The Road To Recovery

Everyone tells you to “Save, Save, Save,” but no one talks about what happens if you can’t save or you found yourself in a pinch and spent all your savings. Are you doomed for a life of poverty? Not necessarily.

When I worked in finance, there was a common theme in every situation I met. All of my financial clients wanted something they didn’t have, and all of them had to work towards it. Whether they had savings or didn’t have savings or even worse, had debt and no savings, there was always a solution. Is it possible to fix financial mistakes? Yes! And one more glimmer of hope: It gets easier along the way.

When it comes to people and their money, the most difficult hurdle to overcome is erasing a deeply ingrained mindset. Like the lavish lifestyle they lead. Or the age they think they can retire. Or their way of buying things and then figuring how to pay for them afterwards. But if they take the right steps to alter course, something interesting happens. As they get closer to their goals by doing things differently, they don’t remember how they did things before. That’s exactly what happened with my clients. That lavish lifestyle of the past? Who cares when you have food and shelter? Retiring at 58 vs. 55? Beats having to think about going back to work at 70. Can’t afford to buy an extra handbag when you have 3 others? Big deal! Those were the responses when I reminded them of where they had come from.

If others can do it, you can too. When faced with one of these hurdles, here is how you can get on the right track.

Living Large. Do you find it hard to save on a monthly basis? Then your answer is to downsize! Cut expenses you don’t need, and lead a more modest lifestyle. For instance, go with a smaller home. Take public transit or opt for a used car. Give yourself a budget for dining out. No matter if you earn $30,000 or $100,000 a year, everyone can afford to save. Don’t just take it from me. Look at how Suze Orman reacts to a millennial who spends $720 a month on a car when she makes $80,000 a year. At least she makes her own coffee.

Retirement Loan Vs. Withdrawal. Normally taking out retirement savings before retirement is a big no-no, but when faced with financial hardship, there might not be a lot of choices. If a retirement loan is allowed, that is the better option compared to a withdrawal, assuming you can pay back the loan later. You will lose out on the opportunity for market gains that you could have seen with that retirement money, but you don’t have to wash away your hard-earned savings. With either a loan or withdrawal, not staying invested will likely carry some impact to retirement. This may mean delaying retirement age or adjusting what life looks like in retirement. Since the rules have changed with the CARES Act of 2020, consult a financial or tax professional before taking a loan or withdrawal from your retirement.

Credit Card Debt. One of the hardest money challenges to get out of is credit card debt. It’s a vicious cycle. Just when you’re done paying one thing, something else strikes and you’re stuck with a new debt. It’s tempting, too, since you’ve done it once, what’s borrowing again? To get out of the cycle, you need to understand the root cause for debt. Where are you spending your money that it’s landing you in debt? If you’re spending more than you make, then you need to draft a budget and stick to it. Freeze or cut your credit card in half and instead use a cash allowance for everything on your budget. If you’re living within your means but still encounter debt, was it the result of an unanticipated expense? Chances are that your emergency fund is too low or that you don’t have one. Rather than putting all available income towards paying off debt, set aside a portion to bulking up your emergency fund. That way, if another unexpected event occurs, you have cash to pay for it, not your credit card.

With a change in perspective and a lot of work and discipline, you can turn around any money situation. Financial challenges can happen, but remember, there is hope!

Homework: What did you take away from watching Suze Orman’s video commentary? Name some of the good and bad financial choices reflected in the video. How can you apply these lessons to your life?

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The Rhyme And Reason For A Roth IRA

Rap Ode To Roth IRA

Here's the thing about Roth IRAs.
Pay taxes now, no delays.
You won't owe any more while your investments grow.
Once you're ready to retire, it's ALL your money to sow!
Add contributions up to the annual max, 
Then pick the investment(s), and see how it stacks!
Don't touch the money before age 59 1/2,
'Cuz taking earnings early costs a penalty and tax.
Don't wait! Start a Roth soon as you can,
Earn that compound interest -- That is the plan! 

The topic of retirement savings is especially pertinent right now for two reasons: either people are considering tapping into retirement savings as cash runs short or on the opposite end, they are looking to invest more money while market prices are low. One type of retirement savings account, the Roth IRA, caters to both. Let’s dive deeper into both scenarios.

Roth IRA – Taking Money Out

Contributions to a Roth IRA can be withdrawn with no penalty and no tax at any time, as they were taxed once already. This is one retirement savings vehicle that offers more withdrawal flexibility than others. However, earnings, or how much your money grows, are subject to both tax and a penalty if taken before age 59 1/2. There are some exceptions to this rule, but a Roth IRA is largely meant to be used for retirement savings.

In response to financial hardships caused by COVID-19, the CARES Act changed a few rules this year. For those in financial need, the early withdrawal penalty on Roth IRA earnings is waived for 2020, and distributions up to $100,000 are allowed before age 59 1/2. These distributions of earnings are considered income and will be taxed as such, but there is the option to spread the tax burden over 3 years or pay back the “loan” within 3 years to avoid paying taxes. Before you withdraw from your Roth IRA, carefully consider what this means for your retirement. In addition, taking money out of any investments could mean selling at a loss. Consult your financial advisor and tax advisor if you are contemplating a withdrawal of retirement savings.

Roth IRA – Adding Money In

For those in a position to invest right now, adding money to a Roth IRA (up to the max) not only takes advantage of stock market lows, but also yields more tax savings down the road if you expect to be in a higher tax bracket in the future. The Roth IRA works especially well when investments have a long time horizon for growth because you get to keep every penny gained without sharing a cut of the profits with taxes.

An attractive option this year may be a Roth conversion, which converts an existing IRA to a Roth IRA by paying taxes on the amount converted. If your income is lower this year than most years, you may fall in a lower tax bracket and therefore, pay less tax on that Roth conversion than you normally would. Furthermore, as a result of the market downturn, your investments may be worth less than previously, so less taxes would be owed. It’s a good idea to check with a financial advisor and tax advisor before making these financial decisions.

Making The Right Choice

No matter the impact that COVID-19 has on our financial lives, savings are still important. In fact, times like these make us realize that having savings gives us one more safety net when falling on hard times. So regardless of whether you are saving for retirement or saving for a rainy day, the point is to remember to SAVE!

Homework: Pay tax now or pay tax later? One reason to choose a Roth IRA (pay tax now) vs. traditional IRA (pay tax later) is if you believe your tax rate will be higher when you withdraw the money. Use the following math problem to understand the difference.

Say you earn $5,000 this year that you pay 20% tax, or $1,000, and you decide to contribute the remaining $4,000 to a Roth IRA. You add no more money to that investment, and it averages 6% annual growth over the next 36 years — How much will your total investment be? (Hint: Use the Rule of 72 to get $32,000 for the Roth IRA.) Assume instead that you defer paying tax until withdrawal by investing the full $5,000 in a traditional IRA– How much will your total investment be after 36 years of 6% annual growth? ($40,000.) After 36 years, if your tax rate is 20%, your total investment will net the same amount in either the Roth IRA ($32,000) or traditional IRA ($32,000) after taxes. If your tax rate decreases to 15% after 36 years, the traditional IRA ($34,000) nets more than the Roth IRA ($32,000). If your tax rate increases to 25% after 36 years, the traditional IRA loses ($30,000), and the Roth IRA wins ($32,000).

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