You’ve paid off your debt, and you have a clean slate. It feels great, doesn’t it? The next big step is building your emergency fund. How much to plan for is up to the individual, based on their situation. However, a general guideline is three to six months, leaning closer to six. Emergency fund money can be from a savings account or a checking account, just make sure the balance is what you carry forward from month to month.
For example, if you continually keep a minimum of $1,000 in your checking account, that $1,000 could be counted towards your emergency fund. How do you calculate your emergency fund? You add up your living expenses for the month, multiply them by three, four, or five or six, and decide which amount works best. And you keep doing that each month until you've reached the amount you planned for your emergency fund.
Once you reach your emergency fund goal, the fun starts with investing. You may initially think, "Meh, but down the road, you'll begin to see the power of compound interest. Your money is likely to grow much faster than it would with a savings account. There are many ways to invest, but we're going to talk about two methods that have some tax benefits that help you stick to the plan and not touch your money until you need it; the traditional IRA and the Roth IRA.
The primary difference between the traditional IRA and the Roth IRA is how the money is taxed. With a traditional IRA, you're putting in pre-taxed money, so your taxable income is lowered by the amount of the contribution your taxable income deducted at the end of the year. With a Roth IRA, you're putting your money in after-tax. You won't take any deductions at the end of the year because it's after-tax, and at the point of retirement or when you take the money out, it is entirely tax-free.
Deciding which IRA to choose will be based on your situation. If you are in a low tax bracket now but expect to be in a higher tax bracket later in life, by doing the Roth IRA, you're paying the tax directly at a lower rate. In the future, when you take the money out, it would be taxed at a much higher rate based on your income at that time. In that scenario, the traditional IRA might make more sense for you because you'll be lowering your tax bill today, and you're likely going to need that money when you're older. So if you're not investing it to give to your kids, the traditional IRA might make more sense.
If you don't make a ton of money and are totally happy with that and see yourself just living off the earth and being very happy and frugal, the traditional IRA might make more sense for you. You'll be lowering your tax bill today, and you're likely going to need that money when you're older and not investing it to give it to your kids.
Another option is having a mix of taxable tax-deferred and tax using both a Roth and a traditional IRA, allowing you to benefit from tax managing flexibility.
Once you have your long-term investing goals in place, you may start to think about new possibilities like finishing that basement or buying a new house. At that point, you should start planning for pre-funding expenses for the bigger ticket items. You don't want to dip into your emergency fund or pull money out prematurely from your retirement accounts.
So you’re out of debt. Now what?
Invest for retirement. Saving earlier than later will help you take advantage of compounding and save on taxes.
The IRS places limits to how much you can contribute to retirement accounts each year. Factors are:
In the episode, I explain the various factors and limits, which you can see in this tax table provided by nerdwallet.
We've covered a lot of foundational things in this podcast, including steps that, for a lot of people, will make sense as a sort of roadmap, then an order of operations on how to get started on your financial journey.
I read an article on Attitudemag.com about a study using brain scans to help diagnose ADHD, which I think is very cool, especially to those science deniers out there. There’s a Reddit forum where people share their stories of ADHD, and one common theme is how medical professionals and other professions like teachers say ADHD is not real. Having brain scans legitimize the diagnosis and identification of ADHD will be a huge leap forward in breaking down the stigma of ADHD and shutting down some of those ignorant or closed-minded people.
Outline of the Show
ADHD brain scan [4:05]
Building your full emergency fund [7:15]
Investing with a traditional IRA [11:20]
Investing with a Roth IRA [15:50]
IRA Rules [19:30]
Prefunding expenses [27:21]
Maxing out 401(k) [28:58]
Resources and Articles mentioned in the show
Brain Scans measure ADHD Inattention - Additude Magazine
IRA Contribution Limits - NerdWallet
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