Ask Liz Weston

Get smart with your money

Saving Money

Q&A: Saving after retirement

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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?

Answer: 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

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Answer: The five-year rule applies, as you mentioned, only to earnings, since contributions to a Roth IRA can be withdrawn at any time. Once you’re at least age 59½, earnings can be withdrawn without penalty provided the Roth IRA has been open for at least five tax years.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

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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

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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?

Answer: 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?

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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

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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.