Q&A: Where should you put your extra cash? Here are some ideas

Dear Liz: At 82, I am selling my house and moving to a senior community. For the first time in my life, I will have a substantial amount of cash. Given my age and the fact that certificates of deposit and savings accounts are currently paying more than 5% interest, does it pay for me to start investing in other ways?

Answer: How you figure out what to do with your money is mostly the same whether you’re 28 or 82.

You start with your goal and your time horizon, or how long you have until you need the money.

For example, you may have to put aside some of the home sale proceeds to pay capital gains taxes if your home has appreciated more than the $250,000 that’s normally exempted from tax. Since the tax bill will be due within months of the sale, you shouldn’t take unnecessary risks with this cash. A high-yield savings account would be a good solution for any money you need to keep safe and liquid.

You also may want to earmark some money for long-term care. This goal is much more ambiguous, because it’s impossible to predict how much you’ll need or when. You may want to consult an elder law attorney, who can discuss your options.

Once you settle on a figure, you’ll want that money to be somewhere safe and readily accessible. Certificates of deposit that mature at different times could be an option, as could the high-yield savings account mentioned above.

If you have a goal that’s many years in the future, you could consider a mix of stocks and bonds. Stocks in particular offer long-term returns that historically beat inflation.

Most working people who want to retire will need to invest in stocks to accumulate and maintain a sufficient nest egg. They can take the risk of losing money in the short term because they have many years ahead for their investments to recover.

And that’s where your situation differs from that of a 28-year-old. The average life expectancy for an 82-year-old male is about eight more years, while the average life expectancy for an 82-year-old female is around nine more years, according to the Social Security Administration.

You may have enough time left to ride out a bad market. But if you don’t have to take such risks to achieve your goals, consider playing it a bit safer.

Q&A: Here’s how to budget your money using the 50/30/20 rule

Dear Liz: What is the formula now for expenses? When growing up, we were told that one-third of net income should go to rent, but recently, I read that 50% is the standard with the remaining 50% divided between wants and savings.

Answer: You may be referring to the 50/30/20 budget, which suggests limiting “must haves” to 50% of after-tax income, leaving 30% for wants and 20% for savings and extra debt payments. (After-tax income is your gross income minus taxes and is often a different figure from your net income. Your net paycheck may include deductions for insurance premiums, retirement contributions and other expenses.)

The 50/30/20 budget was popularized by Sen. Elizabeth Warren (D.-Mass.) and her daughter, Amelia Warren Tyagi, in their book, “All Your Worth: The Ultimate Lifetime Money Plan.” Warren once headed Harvard University’s Consumer Bankruptcy Project and promoted the budget as a way to help people reduce their chances of going broke.

The “must haves” category includes more than housing payments. It also includes other costs that would be difficult, expensive or dangerous to forgo temporarily, such as food, utilities, transportation, minimum loan payments and insurance.

The budgeting rule you grew up with, just like the 50/30/20 budget, was meant to help people live balanced financial lives. Limiting spending on big expenses, such as rent or mortgage payments, helps ensure there’s enough left over to save for the future, pay off the past and enjoy the present.

Of course, many people find it difficult to limit their must-have expenses to recommended levels, especially in high-cost areas. Housing costs alone can eat up half their incomes, or even more. To avoid going into debt, they may need to reduce other spending or saving or find ways to increase their income.

The best free museums in Paris

Museums in Paris typically aren’t cheap, with adult ticket prices often ranging between $15 and $20, depending on the exchange rate. There are, however, a number of absolutely wonderful museums in Paris that are also absolutely free.

Here are some that I highly recommend:

Shops signs in the Musée Carnavalet.

The Musée Carnavalet. This Paris history museum is housed in two gorgeous 17th-century mansions in the Marais district. One of its highlights greets you as soon as you walk in: a collection of shop signs, some dating back to the Middle Ages. Another of my favorite rooms is an intact Art Nouveau jewelry store designed by Alphonse Mucha. Several beautifully decorated rooms, some imported from other mansions, illustrate how the upper crust lived in previous centuries. Downstairs you can see prehistoric tools as well as statues, jewelry and other remnants of Paris’ time as a Roman settlement. Upstairs there’s an extensive collection of Revolution memorabilia as well as maps, models, paintings and other exhibits illustrating the city’s history. Don’t miss the small but well-curated gift shop for unique items, including magnets shaped like some of those iconic signs.

Petit Palais

Petit Palais: The Petit Palais is another Paris museum where the building rivals the artwork. Both it and the nearby Grand Palais are considered outstanding examples of the Beaux-Arts style (think “over the top, more is more” architecture characterized by lots of statues, columns and decoration). The Petit Palais has a fine collection of paintings and sculptures from the 19th and 20th centuries, but I love it for its beautiful interior garden, which you can enjoy while having lunch or coffee in the museum cafe. The Petit Palais is located just off the Champs-Élysées, not far from the Place de la Concorde.

A view of Place des Vosges from Victor Hugo’s apartment.

Maison Victor Hugo. You can check out two Paris must-sees with one visit: the Place de Vosges, a prestigious square in the Marais that dates to the early 1600s, and the home of Victor Hugo, who lived in one of its mansions from 1832 to 1848. Hugo wrote a big chunk of “Les Misérables” here and also indulged in a hobby of reworking old Gothic furniture. He wasn’t a bad draftsman, either; his drawings decorate several of the rooms.

Musée de la Vie Romantique. The “Museum of Romantic Life,” dedicated to the Romantic period in French art and literature, is housed in a compound once owned by painter Ary Scheffer in the Pigalle neighborhood, about a 15 minute walk downhill from Sacre Coeur. The writer George Sand attended salons there, and the exhibits include some of her (surprisingly good) landscape paintings as well as a large oil portrait of her. Once again, a highlight is the museum’s garden and cafe–another great place to rest your feet before heading back out onto Paris’ lively streets.

Musée Cognacq-Jay. Another standout museum in the Marais is the former home of Ernest Cognacq, founder of La Samaritaine department store chain, and his wife, Marie-Louise Jay. The museum’s collection focuses on 18th century art, including  paintings, sculptures, furniture and decorative arts, but more than half the pictures I took were of the lovely mansion itself.

You can find a list of other free museums at Paris’ official tourism site, along with a lengthy list of museums that are free on the first Sunday of the month (including heavyweights like the Centre Pompidou and the Musée d’Orsay). Some of these free-Sunday tickets must be reserved well in advance, however. If you can’t land a slot at one of the biggies, consider my all-around favorite Musée des Arts et Métiers, a science and technology museum that proves the French invented everything of importance, or Cité de l’Architecture et du Patrimoine, a museum of architecture and monumental sculpture at the Trocadéro.

A tip for families: Children under 18 are typically free even at the more expensive museums. Also, free admission is often extended to people under 26 if they’re residents of European Economic Area countries.

Q&A: Mortgage payoff or emergency savings?

Dear Liz: My husband was laid off recently, and he quickly took a new job with a 25% pay cut to continue insurance benefits and the same retirement program. We regularly pay $500 to $1,300 extra on our house payment. We cannot keep that up. However, with his severance package and vacation day payout, we now have more in our bank account than we owe on our mortgage. If we paid off the $80,000 mortgage now (house is valued at $600,000), we’d have an emergency fund of only $10,000, but we could replenish those savings slowly each month with no house payment. We have no other debts. How do we know when is the right time to pay off the mortgage?

Answer: Think about what would happen if you paid off the mortgage and your husband were to be laid off again or you suffered some other financial setback. The $10,000 left in your emergency fund could be depleted quickly. If you don’t have stocks or other assets you could sell, you might have to raid your retirement accounts or turn to high-cost loans.

This is why financial planners recommend having an emergency fund equal to three to six months’ worth of expenses if possible — and why using your savings to pay off a low-rate debt might not be the best use of your money.

If you’re determined to pay off your mortgage, consider setting up a home equity line of credit first. That will give you a relatively inexpensive source of credit in an emergency.

Q&A: Saving after retirement

Dear Liz: I’m retired, age 67. I have a SEP that requires me to pay taxes on any withdrawals. I also have standard savings and checking accounts. The SEP has been earning 13% to 14% annually, and of course the savings account earns very little. Where does it make sense for me to place savings each month — in the bank or the SEP?

Well, not the SEP. A SEP is a simplified employee pension plan that only allowed contributions as long as you were employed by the company that offered it.

Besides, the reason for the difference in returns is what’s in the account, not the account itself. The SEP probably is invested in stocks, while the savings account is just cash earning the current low interest rates. On the other hand, the money in your savings account is FDIC insured so that you won’t lose your principal.

Money in the stock market is at risk because stocks don’t always rise in value. (Over time, a diversified mix of stocks typically will earn better returns than other types of investments, but you can’t count on the money being there if you need it in a hurry.)

If you’re retired and don’t have earned income, you can’t put money into other retirement accounts such as IRAs or Roth IRAs. You can, however, open a brokerage account and invest money through that. You’ll still pay taxes on any withdrawals, but if you hold the investments for at least a year you can benefit from lower capital gains tax rates.

Q&A: Restrictions on Roth IRAs

Dear Liz: I read your useful summary of the advantages of Roth IRAs. I recently retired and decided to open a Roth (I know, pretty late) alongside my traditional IRA. I have an investment manager who will hopefully create some gains in that account. One thing that I learned is that I must wait five years before I can begin withdrawing earnings from the Roth tax-free. For this reason, it might be helpful to encourage readers to open a Roth IRA early, with at least a small contribution, to get the clock ticking toward that five-year deadline.

Answer: The five-year rule applies, as you mentioned, only to earnings, since contributions to a Roth IRA can be withdrawn at any time. Once you’re at least age 59½, earnings can be withdrawn without penalty provided the Roth IRA has been open for at least five tax years.

Hopefully you were also informed about the “earned income” rule, which requires you to have earnings — such as wages, salary or self-employment income — in order to contribute to a Roth or traditional IRA. Contributing more than you’re allowed to an IRA or Roth IRA can incur a 6% excise tax per year for each year the excess contributions remain in the account.

If you do have earned income — say you’re working part time in retirement — you can’t contribute more than you earn. If you earn just $5,000 in a year, for example, you can’t contribute the full $7,000 that’s otherwise allowed to people 50 and older. (The contribution limit is $6,000 for younger people.)

If you’ve contributed in error, contact a tax advisor about next steps.

Q&A: Roth IRA contributions

Dear Liz: I am a retired public employee and receive most of my compensation in monthly payments, for which I get a 1099R form at tax time. The rest of my compensation also comes in monthly installments and I receive an annual W-2 for that. My question is: Can I deposit my W-2 amount in a Roth IRA?

Answer: You must have earned income to contribute to an IRA or Roth IRA — which you apparently have, since you’re getting a W-2 form from an employer. Your ability to contribute to a Roth begins to phase out with adjusted gross income of $125,000 if you’re single or $198,000 if you’re married filing jointly.

Assuming you’re 50 or older, you can contribute a maximum of $7,000 or 100% of what you earn, whichever is less.

Here’s why emergency savings funds never go out of style

Dear Liz: I was a fortunate individual and able to save enough money to cover my expenses for at least six months in case I became unemployed. Now I am retired with a fair amount of guaranteed monthly income through my Social Security and pension benefits. Any suggestion on what to do with that savings account now that it has served its purpose?

Emergency funds aren’t just for job loss. They’re also meant to cushion you against unexpected expenses. If you own a home, a car or a body, you’re likely to experience those in retirement, since all three tend to need repairs as they age.

If you’re new to Medicare or relatively healthy, you may not know that Medicare doesn’t cover all the medical expenses you’re likely to face. Medicare also doesn’t cover long-term care, which can be quite expensive if you eventually need help with daily living activities such as eating, bathing, dressing, getting around and using the bathroom. A study by Vanguard Research and Mercer Health and Benefits found that half of people over 65 will incur long-term care costs, and 15% will incur more than $250,000 in costs.

Q&A: Emergency fund: How big?

Dear Liz: You recently advised a teacher who was inquiring about paying down student debt. You suggested among other things to “have a substantial emergency fund before you make extra payments on education debt (or a mortgage, for that matter). ‘Substantial’ means having three to six months’ worth of expenses saved. If your job is anything less than rock solid, you may want to set aside even more.” Granted, this is in the context of the student debt question, but is that emergency fund advice still valid in light of studies showing the liquidity needs of lower-income households to be much lower?

Answer: The usual advice about emergency funds is often unrealistic and sometimes absurd for most low- or even moderate-income households.

The advice is usually given by financial planners who typically work with higher-income clients. The higher your income, the more likely it is that you have the free cash flow to quickly build a large emergency fund.

An analysis in the New York Times found that a household with income over $200,000 would need about two months to save one month’s worth of expenses. A household with income of $70,000 to $99,999 would need seven to eight months to save one month’s worth. A typical household with two or more people and income of $50,000 to $69,999 would need more than two years to save a single month’s worth of expenses.

As you’ve noted, though, various studies have found that much smaller emergency funds can help households avoid catastrophe.

A 2015 study by Pew Charitable Trusts found the most expensive financial shock suffered by the typical household amounted to $2,000. But as little as $250 can reduce the odds that a low-income household will suffer serious financial setbacks such as eviction, according to a 2016 Urban Institute study.

A three-month emergency fund could be a long-term goal, but it’s not something that should be prioritized over more important tasks such as saving for retirement or paying off high-rate debt.

Such a fund should be a priority, however, over paying off lower-rate, potentially tax-deductible debt. That’s especially true when you’d be making extra payments on student loans. Paying down credit cards can free up additional credit to be used in an emergency, but payments sent to student loan lenders are gone for good.

Q&A: Backdoor Roth IRA contributions

Dear Liz: You mentioned in a previous column that a backdoor Roth contribution could be expensive if you have a large pretax IRA. I was in that situation, and opted to first roll my IRA into my employer’s 401(k). I then made a nondeductible contribution to a new IRA and shortly afterward converted it to a Roth. This allowed me to get money into a Roth without a big tax bill.

Answer: That’s a great solution for those who have access to 401(k) plans that accept such transfers, and many do.

For those who don’t know, backdoor Roths are a two-step process for people whose incomes are too high to contribute directly to a Roth. Instead, they contribute to a regular IRA and then convert that money to a Roth because there’s no income limit on conversions.

Taxes are usually owed on Roth conversions, based on how much pretax money you have in IRAs. But the conversion can be tax free if the contribution was nondeductible, you convert shortly after the contribution and you don’t already have a pre-tax money IRA.

Some questioned the legality of this particular loophole, but Congress blessed it in 2017 as part of the Tax Cut and Jobs Act of 2017.