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Roth IRA: Emergency Fund?

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I recently found out that one of my associates uses her Roth IRA as an emergency fund. Rather than put money into a low yield savings account, or some other cash account, she uses her retirement account as an emergency fund. Technically, the basics of a Roth IRA are conducive to this arrangement. However, you do want to be careful. Think things through before you use your Roth IRA as an emergency fund.

Why Your Roth IRA Could, In Theory, Be An Emergency Fund

In theory, your Roth IRA works as an emergency fund because of the withdrawal rules. You are actually allowed to withdraw your contributions to a Roth IRA at any time, and for any purpose – no matter your age. This means that you can take money out of your Roth IRA with no penalty or tax, as long as you are only withdrawing money that you have sent to the account through regular annual contributions. As long as your withdrawal amount doesn't exceed your overall contribution amount, you don't have to pay a penalty or taxes. Keep in mind that previous withdrawals count against your overall contribution amount.

Roth IRA Emergency Fund

You do have to be careful, though. Withdrawing from your Roth IRA can cost you if you don't do it right. If you are under 59 1/2, and you exceed your contribution amounts (except in certain cases), you might be subject to a 10% penalty and to paying income taxes on the amount. Make sure you know what you are doing before you withdraw money from your Roth IRA to shore up your finances in the case of emergency.

Opportunity Cost

While you might not have the expenses associated with penalties and taxes when you withdraw your contributions to your Roth IRA, you are still subject to opportunity cost. Remember: The money in your Roth IRA is working for you. You are earning interest at a pretty good rate (depending on your asset allocation and market conditions), and if you withdraw principal, you miss out. You can't replace the time that your money might have spent in your Roth IRA, growing with the power of compound interest.

On the other hand, though, some insist that the opportunity cost comes when you put that money in a low yielding cash account as an emergency fund. Because your money (theoretically) grows faster in the Roth IRA, the power of compounding interest at a higher rate makes up for the fact that you withdraw some of your contributions for emergencies.

Bottom Line

What you decide to do depends on what you think is likely to work best for you, and provide for your needs. If you plan ahead sufficiently, it should be possible to get quite a bit built up in your Roth IRA. Of course, for it to work, you need to make sure you only withdraw contributions in cases of true emergencies. If you use your Roth IRA as an ATM, you could easily remove all of your contributions quickly — and then move into penalty areas where it starts costing you more. Make sure you carefully evaluate your situation before adopting this emergency fund strategy.

How We Paid Cash For Our New Car

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Over the past 3 weeks my wife and I have been searching for a new car. We hadn't originally been in a hurry to buy a new car, but an opportunity presented itself where we could sell our current car, a 9 year old Honda Civic, at a decent price to a family member. The family member had purchased a Toyota Camry 20 years ago, and it had finally quit on him and was going to be more to repair than it was worth. He decided to cut his losses, save the money and look for a quality car that would last him another 10-15 years. He thought our car fit the bill since he knew we treated our cars well, it still has relatively low mileage, and Honda is known for their reliability.

Since he needed the car within a week or two, we had to start looking immediately. Thankfully because we pay ourselves a car payment even when we have paid off cars, we had the cash in the bank to be able to go and buy a new car on short notice – without having to get paid for our car first, get approved for a loan at a bank, or financing at the dealership.

Paying cash for cars

Paying Cash For Your Car: Not Normal?

We know that not many people nowadays actually do what we do – paying cash for their cars.  Paying for a car is one of the most expensive things most people will buy, right behind buying a house.  If you don't plan ahead far in advance, you won't be able to do it, and financing a car will be in your future.   Who can pay $10,00-25,000 for a vehicle without planning ahead?  Not many people make enough money to do that.

Saving up and paying cash for your cars, while it may not be normal – is a good idea.  After you've done it a few times you'll have enough cash saved in order to buy a nice 2-3 year old used car every 5-10 years, while never paying thousands in interest again.

Car Payments – A Fact Of Life?

Most people just assume that having a car payment is a fact of life.  After all, cars are expensive, and most people just don't have thousands of dollars laying around.    So what is the average car payment?  Dave Ramsey's site recently told us what one study found:

Recent statistics show that one-third of car buyers sign up for a six-year loan at an average interest rate of 9.6%. Among these buyers, the average price of the car is just over $26,000. This means that one-third of the cars you see on the road are dragging a $475 payment behind them.

So 1/3 of car buyers have an average of a $475 car payment over six years at 9.6%.  That means they'll end up paying nearly $33,000 for a  car that retails for about $26,000.  On top of that, the car will only be worth on average about $6,000.  That's quite the loss!  So why not make car buying more affordable, while at the same time freeing up more money for saving and investing?

Buy A Cheap Car.  Work Your Way Up.

So how do you get started paying cash for a car? For me it meant that my first car was a bit of a beater.  My first car was a 1986 Chevrolet Caprice Classic station wagon with 140,000 miles on it.  I saved up the money from a high school job and paid $1500 in cash for it.  It had cigarette burns in the upholstery, and was a gas guzzler, but it was paid for in cash.  That car lasted me a few years during which time I still saved up money for my next car (which would hopefully be a bit nicer).

When the old Caprice died, I ended up buying a slightly more expensive $6000 1996 Dodge Intrepid with 70,000 miles on it.  That car lasted me another 5 years.  When it started having engine problems I traded the vehicle in for a couple thousand, and used that money and the payments  i had continued saving in the meantime to buy my next car, a 2001 Chevrolet Lumina.  I paid $7000 in cash.    That car lasted 7 years, at which time we paid cash for my current 2006 Chevrolet Impala.    We got the money from my old trade, plus the payments we had saved to buy it for $10,995.

So as you can see I've been saving up and paying cash for cars for the last 15 years or so, and never have I paid interest on any of those cars.  Each time we buy a car we purchase one that is a bit newer, and in a bit better shape.  That means the car lasts us longer and we're able to save up more for the next car.   My current car has been with me for only 3 years, and I'll probably keep it for at least another 5-6 years at least.  I've got a number in mind of how much I'll want to spend then.  So in the meantime I'll continue paying myself a car payment until i reach that number.  At that time I'll take that money and start investing it for our future!

My wife has followed a similar process, starting out with an older used Honda over a decade ago, and working her way up to our current 2009 Honda CRV which we purchased last week.

Paying Yourself For Your Next Car, Not The Bank

So the essence of how this whole process works is this:

  • Buy a beater:  Save up and pay cash for an affordable and reliable “beater” that should get you by for a couple of years at least.  Don't forget to save up an emergency fund to cover any auto repairs that may come up.
  • Pay yourself a payment: Pay yourself a car payment instead of the bank now that you have a paid off car.  Use that money to pay cash for your next car.  This car could be a bit nicer and more reliable since you'll be able to sell your old beater for at least some return, plus you'll have they money you've saved.
  • Wash, rinse, repeat:  Save up and pay cash every time you buy a new car.  Every time you do buy a car you'll most likely be able to buy a nicer car as you've had longer to save, and more money to spend.  The newer and more reliable the car, the longer you can own it – and the more you can save for your next car.
  • Invest the difference: Take the money you've saved on interest payments and invest it!

Of course this scenario is going to be different if you're one of those people that prefers to have a new car every few years.  for a slightly different take on the subject, and how you can upgrade your vehicle twice in 20 months –  check out Dave Ramsey's post on the topic.

Have you ever paid cash for a car, or are you considering doing it now?  If not, what has kept you from doing it?

Lower Your 2011 Tax Bill by Going Green With Home Energy Tax Credits

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Although the U.S. government's ability to function is heavily dependent upon tax revenue, taxpayers are not completely forgotten about. In fact, the government offers taxpayers breaks for taking certain actions or making certain purchases that are good for themselves, the economy or the environment. One such break is a tax credit available to homeowners who make energy-saving home improvements and upgrades.

Last December, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which extended numerous tax credits to both taxpaying individuals and businesses, including those making home energy improvements. Some of these home energy tax credits will continue to be allowed for the 2011 tax year and beyond, although most are lower than the last two years. Nevertheless, it is well worth the small effort needed to maintain any records so that you can claim these tax credits at the end of the year if you qualify.

Last December, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which extended numerous tax credits to both taxpaying individuals and businesses, including those making green energy improvements. These credits will continue to be allowed for the 2011 tax year, although they are lower than the last two years at just $500 for the lifetime of the taxpayer. Despite this, however, it is well worth the small effort needed to maintain any records so that you can claim these tax credits at the end of the year if you qualify.

The Benefit of Claiming Tax Credits

Unlike a tax deduction, which only lowers your taxable income by the amount of the deduction, a tax credit – as its name suggests – is a credit toward the taxes that you owe. In other words, it is a dollar-for-dollar reduction in tax liabilities. For example, if you owe $1,200 and receive a $500 tax credit, you will only owe $700 on your tax bill. In some cases, tax credits may result in your receiving a refund under circumstances in which you may otherwise have owed money.

Changes to Some Home Energy Tax Credits in 2011

While the good news is that some residential energy tax credits that were set to expire at the end of 2010 are being extended through 2011, the bad news is that there is now a total lifetime cap of $500 for the following energy-efficient improvements:

  • Heating, Ventilating & Air Conditioning (HVAC) Equipment – Includes furnaces, boilers, air source heat pumps, advanced main air circulating fans and central AC. (Central AC capped at a $300 credit, electric heat pumps capped at a $300 credit, furnaces and boilers capped at a $150 credit, main air circulating fans capped at a $50 credit)
  • Insulation – Typical bulk insulation products, such as batts, rolls, blow-in fibers, rigid boards, expanding spray and pour-in-place, as well as many products designed to air seal, such as weather stripping, caulk, house wrap and spray foam in a can, are included.
  • Metal & Asphalt Roofing – Metal roofs are required to have appropriate pigmented coatings, asphalt roofs are required to have appropriate cooling granules, and installation costs are NOT included.
  • Non-Solar Water Heaters – Includes qualified natural gas, propane or oil furnaces and hot water boilers. (Furnaces are capped at a $200 credit and must be 95% efficient.)
  • Energy-Efficient Windows, Doors & Skylights – Also includes storm windows and doors. (Credits for windows are capped at $200).
  • Biomass Stoves – Must have a thermal efficiency rating of at least 75%. Biomass stoves can burn agricultural crops, wood, plants, grasses, residues, and fibers. (Credits for biomass stoves are capped at $300.)

The $500 lifetime cap is a rather significant reduction from the $1,500 cap that existed previously. This means that if you have already received at least $500 total in energy tax credits through 2009 and 2010, you are no longer eligible to claim these tax credits. On the other hand, if you have only claimed a portion of the $500 threshold so far, you are still eligible to claim the remainder of it as long as you make qualified improvements before the end of this year. For example, if you have only used $300 in credits, you still have $200 left for 2011.

Another major change to these energy tax credits this year is that it only extends to 10% of the cost – down from 2009 and 2010, when it was 30% of the cost – so you will need to spend $5,000 in order to receive the full $500 tax credit. However, if you are already planning to make some of these qualifying energy-efficient home improvements discussed above, it is in your best interest to make these changes before the end of 2011. If you are not already planning to upgrade at this time, you may want to consider how much money you will save long-term by upgrading to an energy-efficient appliance sooner rather than later.

If you are eligible for the aforementioned energy tax credits, you must complete any qualifying home improvements before the end of this year in order to receive these tax credits as they will expire on December 31, 2011.

Eligibility Guidelines for the Home Energy Tax Credits Discussed Above

It is important to be aware of the many rules and restrictions limiting what is eligible for the energy tax credit and how much you can claim. You will certainly not want to get to the end of the year thinking that you have tax credits, only to discover that you have purchased and installed ineligible systems.

The residential energy tax credits are a bit complicated in that:

  • Improvements must be made to an existing home
  • Improvements must be made to your principal residence
  • Only certain home improvements are eligible
  • Only certain appliances and systems are eligible
  • There are individual caps on many items.

Home Energy Tax Credits Through 2016

Fortunately, many residential energy tax credits will not expire till December 31st, 2016. These include geothermal heat pumps, small wind turbines and solar energy systems, as well as residential fuel cell and microturbine system installations. The first three aforementioned home improvement energy tax credits have no upper limit or cap and can get you a tax credit of up to 30% of the total cost (including installation costs). For residential fuel cell and microturbine system installations, you can obtain a tax credit for 30% of the total cost (including the installation) up to $500 per .5kW of power capacity.

Eligibility Guidelines for Home Energy Tax Credits Through 2016

Just like the other home energy tax credits expiring this year, there are some limitations on the energy tax credit. However, these limitations are much less restricting. Here are the major differences in the limitations:

  • Improvements may be made to an existing and new construction homes
  • Improvements may be made to your primary residence and your second home (except for fuel cells which only qualify for your primary residence)
  • There are no individual caps.

Claiming Energy Tax Credits on Your 2011 Tax Return

In order to claim energy tax credits on your 2011 tax return, you must take the following steps:

  1. Plan your home improvements wisely and consult the ENERGY STAR website to see which improvements are eligible to claim, and whether you can claim installation costs for certain systems and improvements
  2. Keep your receipts and Manufacturer's Certification Statements in a special folder so that you can add them up at the end of the year. You must be very clear about which items you purchased during the year.
  3. Record your spending on IRS Form 5695 and submit it with your 2011 tax return. On IRS Form 1040, the residential energy tax credit is claimed on line 52.

Learn More

You can obtain more information, eligibility requirements and other details on qualifying products at both Alliance to Save Energy and ENERGY STAR. Or consult a tax professional to see how you may be able to benefit from the residential energy tax credit, as well as the many other tax breaks available.

For you, as the taxpayer, making home improvements that save energy creates a win-win situation, where not only will you reap a short-term benefit by receiving the tax credit, but you will also enjoy the long-term advantage of saving a great deal of money on your energy bills.

This guest post was provided by Manny Davis. His website contains a frequently updated tax blog with tax news, tax changes and tax saving tips, as well as detailed guides to help people through various tax related problems.

Buying A Used Car? Watch Out For Flood Damage

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One of the ways you can save money when you purchase a car is to buy it used. Used cars can provide you with a great way to get from here to there — without breaking the bank. Plus, you avoid the instant depreciation that comes the moment you drive a new car off the lot.

You still need to be careful, though. Thanks to the high water in many parts of the country during the spring or hurricane season, there has been an increase in the number of used cars on the market that have been damaged by flooding.

Car With Flood Damage

Why You Don't Want A Car With Flood Damage

Before you buy a car, you need to understand that there are a number of problems that can come with flood damage to a car. When that much water infiltrates anything — especially if it sits — there can be very real problems. Some of the issues that comes with flooding include:

  • Mold and mildew: So much moisture can lead to mold and mildew in the car. This can ruin carpeting in your car, as well as smell nasty. Mold and mildew can also trigger allergies in some people, making it very unpleasant to be in your car, and further destroying what's left of the car's value.
  • Electrical problems: All that water in the car can damage electrical systems. This means that you could end up with shorts in the system, or components not working right. You might buy the car, only to find that it needs expensive repairs on the electrical system.
  • Body damage: Peeling paint can result from flood damage, but one of the real issues is rust. Flood damage can accelerate the rate at which the car rusts, and that can lead to expensive structural problems.

Sometimes, flood damage isn't obvious, though. Many sellers try to cover it up with new paint, and with other gimmicks. If you just give the car a once-over, you might not realize that the car has been in a flood.

Avoid Buying A Flood Damaged Car

Most states have laws that require that title documents reflect flood damage, or mention that a car has been through a flood. However, this doesn't protect you in instances when the state doesn't have such a law — or if someone flouts the law. You can check a Carfax report to see about flooding (most reputable dealers will provide you with a free Carfax), but sometimes the flooding happened too recently, or some method was used to avoid having the information reflected on Carfax. You can also get a free report at www.nicb.org, the site of the National Insurance Crime Bureau. Always inspect the title of the car, and ask for the former owner's contact information if you are buying from a dealer.

As you look over the car, check carefully for signs of possible water damage. You should also have your used car inspected by a mechanic you trust. This typically won't cost very much, and it can provide peace of mind as you buy the car. Plus, a good mechanic will be able to spot the tell-tale signs of flood damage — and attempts to cover it up.

How To Invest Money For Your Kids

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According to the United States Department of Agriculture (USDA), the average cost of raising a child rose to over $222,000 in 2009. (1) The 2010 annual Expenditures on Children by Families report revealed that the cost of raising a child rose by less than 1 percent from 2008. A big portion of this expense goes towards paying for college. According to a report published in the Christian Science Monitor, the cost of college has risen 440 percent over the past 25 years, four times higher than the inflation rate. (2) The schools with the best reputations cost upwards of $200,000 for four years.

Parents have to start planning early to invest on behalf of their children. Starting an Individual Retirement Account (IRA) or a 529 savings plan or other tax-advantaged account will help parents provide for their children when they come of age. In tough economic times, planning ahead for favorable and unfavorable circumstances is paramount to helping one's children have a successful life.

Setting Up An Account

Three questions must be answered. Who will own the account? What type of account will it be? What kind of assets will the account hold? These questions will decide the entire account ahead of time, avoiding confusion and errors due to changing circumstances. The goal of the account is to accumulate the largest amount of cash possible after taxes while compensating for inflation. A secondary goal is to teach children about investing as they grow older.

Generally speaking, it is best for the account to be in the parent's name but have a legal structure in place that transfers it to the child when he reaches the age of maturity. A custodial account answers this purpose very well. A custodial account's earnings are taxed at the child's tax rate instead of the parents’. In other words, taxes are practically nonexistent, allowing 18 years or more of compounding returns.

Retirement

The stock crashes of 2000 and 2008 wreaked havoc on the portfolios of future retirees. Subsequently, most of them have had to postpone their retirement dates or cancel them completely. Traditional IRAs and Roth IRAs are both tax-advantaged, but a Roth IRA is more flexible which can help when raising a child. The contributions, but not the earnings, from a Roth IRA can be withdrawn tax-free at any time for any reason. Traditional IRAs impose a 10 percent penalty for the same action.

Unfortunately, only $2,000 per year can be contributed to a Roth IRA. What's more, if the Roth IRA will be in the child's name, he has to earn money in order to have one. This means having a Roth IRA in the child's name is not feasible until he is old enough to work.

Saving for College

After retirement, the next most important goal is college. Again, the cost of college has risen four times faster than inflation over the past quarter century. One of the easiest ways of saving the amount needed to pay for college is a 529 plan. Signed into law in 1996, a 529 plan's earnings accumulate and grow tax-deferred. Distributions for educational expenses are tax-free and penalty-free. The 529 plan is a state-sponsored plan, which means that the state sets up the plan with an asset management company. The parent then opens a 529 account with the company.

529 plans actually come in two types. The first type is the tax-advantaged account, and the second type allows the parent to prepay tuition by purchasing credits at current tuition rates for the beneficiary. Most parents prefer the tax-deferred account to take advantage of compounding returns.

References

(1) http://www.cnpp.usda.gov/Publications/CRC/2010CRCPressRelease.pdf
(2) http://www.csmonitor.com/layout/set/print/content/view/print/402577

Tal Baron writes for Currensee, a FOREX trading social network offering some of the best investments in currencies.

Is Your Home Really Going To Be A Retirement Asset?

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Many of us were raised to believe that buying a home is the key to a stable financial future. It is true that your home is likely to be your biggest purchase, but it may not do to rely too heavily on your home's equity for retirement.

The theory is nice: You buy a house, pay it off over 30 years, and when it's time to retire you have this huge asset, which has appreciated in value, ready to be tapped. Before you get excited about the prospect, though, it's a good idea to take a step back and evaluate whether or not your home will really be the asset you think.

Home Equity

Will It Appreciate As Much As You Think?

The first thing you have to consider is whether or not your home will appreciate as much as you think. You will need to consider the costs of home ownership, including the interest that you pay, as well as maintenance and upkeep. You can expect to offset some of the costs of interest and property taxes with the help of tax breaks, but you can't expect those to last forever. You will have to consider the effects of inflation as well.

The other issue, of course, is whether or not a market crash happens just before you retire. Many people who had depended on their homes for retirement received a rather unpleasant surprise after the recent real estate bubble burst and home values plummeted. Suddenly, the expected value disappeared.

While your home can be an asset to draw on later, you might not want to rely too heavily on the expected equity in your home to fund your retirement. Like any other asset that we expect to appreciate in value, there is the risk of loss, and you can't predict what the market will do. A little diversity is usually in order.

Tapping Your Home Equity

One of the reasons that many buy a home is for the ability to tap the equity later. However, tapping your home's equity comes with its own costs. You will have to pay even more in interest, since you will have to borrow against the equity in your home to access it. If you are retired, you may have difficulty getting a traditional home equity loan, since you will need income. You might have to use a reverse mortgage. While you won't have to repay the mortgage until the house is sold, or you stop living in the house, many reverse mortgages have steep fees and interest rates, and can erode the amount you receive.

Of course, you can sell your home to downsize. If you have paid off your mortgage, you can sell, and then use the resulting capital to buy a smaller home, or invest the capital for income. (Or, if you have enough left over, you could buy a smaller home and invest.)

Bottom Line

If all goes to plan, it is quite possible that your home can be a place for you to live, as well as provide you with an asset to use to your advantage during retirement. However, it is important to understand that you might not end up with what you expect, and to consider making any real estate asset a part of your larger retirement portfolio, adding diversity.