When it comes to finances, you may have to make tough decisions, such as whether to establish an emergency savings fund or save for retirement with a traditional IRA or a Roth IRA. By looking at your current financial situation and the advantages of your options, you can decide which way to go. You may even be able to accomplish both goals simultaneously.
Individual Retirement Accounts, or IRAs, are retirement vehicles that offer a variety of benefits. Traditional IRAs are tax-deferred, so you don't have to pay taxes on the earnings until you withdraw the funds. There are no income requirements for contributing to a traditional IRA. You can contribute up to $6,000 per year if you are over age 50, or up to $5,000 per year if you are under 50. However, you must begin taking minimum distributions from the account when you are 70 1/2, or you will have to pay stiff penalties. If you take funds out before age 59 1/2, you will have to pay penalties and taxes on the amount you take out. However, there are some circumstances in which you don't have to pay penalties on early withdrawals, such as if you use the funds for college expenses, medical expenses that exceed 7.5 percent of your adjusted gross income, or a first-time home purchase with up to $10,000 in funds. Although you will not have to pay penalties for funds used for these reasons, you will still have to pay tax on the amount you withdraw.
Establishing an emergency savings fund is important so that you'll have funds immediately accessible in the event of an unforeseen circumstance. Financial expert Suze Orman recommends that you have at least eight months of living expenses stashed away. She recommends that this savings be in an insured location and not in the stock market. Fox Business financial guru Dave Ramsey says that he would temporarily suspend any contributions to a retirement account in order to establish an emergency savings account.
A Roth IRA can act as a combination retirement and emergency savings fund. Because the funds in a Roth IRA are after-tax dollars, you do not incur tax penalties if you withdraw your contributions; you only incur penalties when you withdraw your earnings prior to age 59 1/2. There are also no penalties incurred if you withdraw earnings under certain circumstances including for the payment of college expenses, medical expenses that exceed 7.5 percent of your adjusted gross income, or for a first-time home purchase with up to $10,000 in funds. You can contribute up to $5,000 per year to your Roth IRA if you are under age 50, or $6,000 per year if you are over 50 as of 2012. While you have non-penalty access to your contributions -- that access isn't immediate. If you mail a request for a withdrawal and request a paper check, you may wait more than two weeks before you receive the funds.
It's possible to save for retirement and have an emergency savings at the same time. For example, you can put half your available funds in an emergency account, while splitting the remainder between a traditional IRA and Roth IRA. The specifics of your personal financial situation may heavily influence your options. For example, if you anticipate having large expenses in the near future, such car or home repairs, you might want to add funds to an emergency account that you can access easily. If you anticipate that the market will go up and you do not have a large need for emergency funds, you may want to add more funds to an IRA.
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- Kiplinger: Build an Emergency Fund or Invest for Retirement?
- Bankrate.com: Traditional IRA vs. Roth IRA
- IRS.gov: Retirement Plans FAQs Regarding IRAs
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