Saving in triplicate

Q:  I have been a member of USAA since 1998.  I have a question on savings.  I deployed and during my deployment I paid off all bills and started saving money.  I have that in a money market and an emergency account with $500.  I know the rule is to have six to eight months of emergency funds.  Should I keep those accounts separate and build up the emergency funds and continue to put money in the money market?  I currently contribute the maximum to my Roth IRA.  Should I just rely on my Roth when I retire?

--Michele

A:  Talk about turning lemons into lemonade!  Good job using your deployment to your financial advantage.  First, your emergency fund should be a separate account to make it less easy (or tempting) to dip into.  And, yes, a money market or similar cash account works just fine.  I actually recommend adding to the emergency fund each month, even after you have the full six months worth of expenses socked away.  That way it automatically “refills” if you need to use it. 

Regarding your Roth IRA, please accept another well-deserved pat on the back!  It’s great that you are maxing out your Roth with $5,000 (2009 limit is $5,000).  However, your Roth IRA alone is probably not going to be enough to fund your retirement.  Once you get your emergency fund in ship shape and up to at least 3 months of living expenses, I would encourage you to supplement your Roth savings in two additional ways.  The first is contributing to the Thrift Savings Plan (TSP).  The TSP is just the opposite of the Roth in terms of taxes:  you save tax money currently and commit to paying taxes in the future during retirement.  Second, I recommend you invest for the long term in mutual fund accounts outside of the TSP and the Roth.  When you liquidate those funds down the road, your investment gains will be subject to long term capital gains tax which is capped at 15% currently (if the investment is held for a year or more).  The result of combining those three strategies achieves tax diversification which will allow for having some control over taxes in retirement.  

 

I know I don’t sound like much fun! Save in triplicate. But you seem like an effective financial manager, so you should have some money left at the end of the day for more fun stuff! Keep up the good work.  And, thank you for your membership!