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Funding an IRA When You’re Not Sure You Can Afford It

Written by Nickel - 23 Comments

Have you maxed out your traditional or Roth IRA for 2007? If not, you have until Tax Day to get it done, so you better get crackin’. Given that the maximum allowable contribution for 2007 is $4,000 ($5,000 if you’re age 50 or more), and assuming that you contribute once a month from now through April, you’ll need to squirrel away just shy of $667/month to reach the max ($833/month if you’re 50 or older).

Even if you can’t hit that mark, you should do what you can to pump money into your IRA. After all, IRA contribution limits are a “use-it-or-lose-it” proposition. If you fail to contribute in any given year, you can’t carry the unused portion of your contribution limit forward to the next year. And remember…

You can withdraw your Roth IRA contributions (but not earnings) at any time, for any reason, without taxes or penalty. Thus, even if you have other savings priorities (e.g., building up an emergency fund) you can safely stretch your budget and stuff a Roth with money.

(Note that this sort of withdrawal flexibility applies only to Roth IRAs, not traditional IRAs.)

Worried that some sort of emergency might arise? No sweat, you can always get your money back out if you end up needing it. And if things work out and you’re able to leave the money in place, then you’ll be one step ahead of the game. You can’t go back and make those contributions in future years if you miss your chance now, so do it while you still can.

Note that IRA contribution limits for 2008 are $1000 higher.

Sound like a plan? Just be sure to keep that money in a safe, stable investment if there’s any chance that you might need to pull it back out and use it in the near future. If things work out and you’re able to leave your contributions untouched for the long term, you can always move into more aggressive investments later.

Note: The point of this article is not to encourage you to raid your Roth IRA in a pinch. Rather, it’s to encourage you to take advantage of a Roth IRA even if you’re not entirely comfortable earmarking that money for retirement.

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Published on November 9th, 2007
Modified on February 19th, 2008 - 23 Comments
Filed under: Retirement, Saving & Investing, Taxes

About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

23 Responses to “Funding an IRA When You’re Not Sure You Can Afford It”

1
Stephanie Says:
November 9th, 2007 at 10:10 am
I was wondering/worrying about this a little. I realized I started my Roth halfway through this year, and I wont max out my $4000 limit. I think your post helped me get over the fear of moving money into my Roth to max it out. I currently have a decent amount of money in my (not-so-much-anymore) high yield account at ING. So I guess I just have to move it over to my Roth, eh?
2
nickel Says:
November 9th, 2007 at 10:15 am
Yes, but like I said… If you think you might need to pull this money back out in case of an emergency, be sure to invest it very conservatively. Once you’ve built your non-retirement accounts to a point where you’re confident you won’t need this money anytime soon, then you can move to a more aggressive investment strategy.
3
Jason Says:
November 9th, 2007 at 10:27 am
I was wondering about this. If you do need to pull some money out of your Roth IRA in an emergency, can you put it back in when times get better? Or does the money you put back in count towards your $4000 max?
4
nickel Says:
November 9th, 2007 at 10:34 am
Jason: Once it’s out, it’s out. You’re then subject to the limits when it comes to putting it back in. Thus, you don’t want to pull money out on a whim.
5
Swing Ninja Says:
November 9th, 2007 at 10:45 am
I’ve been funding my ROTH using credit card. You can do that if you open it through Bank of America. The only caveat is that you can only use Master Card or Visa. And of course you need to be smart to use 0% or low interest CC.
6
MoneyNing Says:
November 9th, 2007 at 5:34 pm
Swing Ninja: WHAT?!?!? That’s news to me! In that case I need to look into bank of america IRAs since I get a free 2% that way (through rewards).
7
Tim Says:
November 9th, 2007 at 6:18 pm
I understand your “note”, but this is just troubling to me. You shouldn’t be investing in retirement vehicles with the mindset that you are going to tap it when you are in a pinch. If you have any concerns about needing money in a pinch, then you need to establish an emergency fund first then fund your RIRA.

yup, you can fund your Bank of America IRA with a Mastercard or Visa to incude bank cards by MC or V. The only question not answered on BofA’s site is what kind of charge is it on your credit card–that is, POS cash advance, debit, or cash advance. If cash advance in any form, then it isn’t a good idea since you immediately start to accrue interest on cash advances plus you don’t earn any “cash back” from your credit card. If it is a regular debit charge, then it is worthwhile if you have a 0% credit card. If you are going to pay the amount debited in full each month, then sounds like a winner deal. If you are going to carry a balance, even if it is a low interest card, then you aren’t doing yourself any favors and have a chance of losing more money than you will make.
8
nickel Says:
November 9th, 2007 at 10:23 pm
Tim: You can have your cake and eat it, too. If your choice is emergency money vs. retirement investing, then clearly you don’t want to lock up the emergency money. But by sticking it in a Roth, you’re not locking it up. Rather, you’re keeping your options open.

If you opt for a bank account, then you lose out on your 2007 contribution limit (forever!). That’s just short-sighted. Instead, stick the money in a Roth, invest it in something conservative like a money market mutual fund, and then keep on saving. If you luck out and don’t need the emergency funds, then you’re ahead of the game by having taken advantage of you 2007 contribution limit and you can eventually move these funds into a more aggressive vehicle. If you do end up needing it, then you can withdraw it and use it just like you would have if the money was in the bank.

This is not a ‘tap into your retirement’ mindset. Rather, it’s a ‘jumpstart your retirement if at all possible’ mindset.
9
kitty Says:
November 10th, 2007 at 10:23 am
If you are expect to be in the phase out range or think you may have capital gains (or distributions), it make sense to wait until January to see what your allowed contribution will be based on your total income and interest then. You have until April 15th next year, so there is still plenty of time.

I’ve been contributing after the year is over for the past few years, but managed – mainly thanks to 401K reducing my income. This year, I’ll definitely be in phase out range even without additional gains; if I end up selling any of the stocks or getting distributions from a mutual fund, I’ll likely be over. Still undecided about putting money in the IRA instead and hope for the government not to change its mind in 2010.
10
fortune8 Says:
November 10th, 2007 at 12:06 pm
Nickel

Nice write up. I wonder if any of my clients read blogs.

However, I have been telling clients that if you have a savings account and not a ROTH, then you are throwing money away.

Clients want me to find them ways to save money on taxes, but when I do that, they don’t listen. Go Figure!

The maximum contribution for 2007 is $4,000 and 2008 is $5,000.

Your contribution is determined by your income.

This was made for the middle class as the rich and wealthy currently cannot contribute to a ROTH.

Here is a hypothetical example.

Let’s say you are married and have $18, 0000 in the bank that earns 5% simple interest a year.

In one year, you would have earned $900 in interest. If your total tax rate is 40%, then you pay $360 leaving a net of $540.

Now if this was in a ROTH account, that $900 interest would be tax free!

Using the $18,000, you can ladder the CD.

Open up 3, 6,9,12 months CD with $2000 for a total of $8,000.

One month later, open up another 3, 6,9,12 months CD with $2000 for a total of $8,000.

This leaves you $2,000 in the money market, $16,000 in CD’s, and accessibility to the money every 3 months if needed.

Don’t need the money, let the CD’s renew and earn compounded interest.

People should put money into ROTH with a mindset of saving for retirement and not saving for emergencies because if you take the money out for emergencies, then what will you have for retirement?
11
DebtyBetty Says:
November 10th, 2007 at 1:42 pm
I actually just opened up a Roth IRA at T Rowe Price. I like the fact that it was simple, I just entered in my age and it suggested the appropriate retirement fund, but what I especially liked was that they don’t have a minimum starting balance as long as I contribute $50 per month, which I can totally do. (Vanguard was $200/month, which was too much of a stretch). Plus, since I’m opening it now, I can contribute all January-April contributions to the 2007 Roth instead of the 2008.
12
nickel Says:
November 10th, 2007 at 4:22 pm
“People should put money into ROTH with a mindset of saving for retirement and not saving for emergencies because if you take the money out for emergencies, then what will you have for retirement?”

I couldn’t agree more. However, if the alternative to is not fund the Roth, then I think the approach outlined above is far superior.
13
Stephen Says:
November 10th, 2007 at 5:31 pm
I guess what always gets me is the whole IRA vs 401k thing for myself and my wife. Currently her and I each have 200 bucks taken out monthly to fund a Roth IRA of ours. So that is 2400 a year, which is nothing superb.

We both have 401k’s through our respective jobs, and currently her contribution is 20% and mine is 25%. I also get a 4% contribution from work. So this year right now we have put about 23k away in our 401k’s so far.

I know there are like 40 variables at play, but I guess the question is, should we be cutting the 401k back and maxing out the Roth instead first? I know that 401k really drops our taxable income a lot, so that gives us more money that is not going to ‘The Man.’
14
speedy Says:
November 11th, 2007 at 8:31 am
I can see the advantage of earning interest tax-free in a Roth IRA. However, part of the reason I keep my emergency fund in a savings account is to have quick access to the funds in the event of an emergency.

If the money is in a Roth IRA, how will I be able to get it out quickly if I need it? Would there not be a lot of paperwork involved, and then a delay in processing it? That is what worries me.
15
nickel Says:
November 11th, 2007 at 9:17 am
speedy: It probably depends on your custodian. In our case (with Vanguard), it would take about 2 days to get our hands on the money (via electronic transfer).
16
fortune8 Says:
November 11th, 2007 at 9:25 pm
If you are using Roth IRA for emergencies and want quick access, try the local credit union and bank. We can walk into our credit union and withdraw cash as if it was just a savings account.

One more thing, make sure you don’t have any custodial fees or closing fees.
17
Tellingnot Says:
November 12th, 2007 at 6:10 pm
Thanks for this article!

I’ve been looking at personal finance blogs for the last several months (since I graduated from college in May) and this is excellent information that I will look into.

I currently have no retirement savings — all of my savings have been going into an “emergency fund”; my job is not steady and I’ve feared opening an IRA because of losing access to money in case of emergency (or lack of employment).

I know that withdrawing money from a Roth is a less than ideal choice, but for me, when I assumed I’d have to wait a couple of years to open one, this is fantastic news.
18
Stephen Says:
November 12th, 2007 at 6:18 pm
Tellingnot: all i can tell you is the earlier you start the better!!

I am only 28, so I feel like I am ahead of most people at my age. My wife and I just saw the financial adviser today actually and we are doing pretty good. but start now if you can, even if its a 100 bucks a month or something.
19
headscratcher Says:
November 15th, 2007 at 9:47 am
How come this item says 25 comments but there aren’t even 20 comments to read?
20
nickel Says:
November 15th, 2007 at 9:49 am
There are currently seven trackbacks/pingbacks (below) which get counted as comments. These are auto-generated “comments” that happen when someone links to one of my articles.
21
kimberly Says:
January 27th, 2008 at 2:43 pm
I have a Roth IRA and was wondering if I can contribute more than my Adjusted gross income ( which is less than $4,000) without any other penalties?
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