Falling Behind? The RIGHT Way to Catch Up This Year
Digest
This podcast episode tackles various personal finance questions from listeners. It begins by introducing the "Financial Order of Operations," a system prioritizing debt reduction, building an emergency fund, and then investing in tax-advantaged accounts like HSAs and Roth IRAs. The hosts then discuss strategies for maximizing Roth IRA contributions, especially when approaching income limits, suggesting dollar-cost averaging and the "backdoor Roth" method. The episode also explores the trade-off between maintaining a large emergency fund and investing excess funds in an after-tax brokerage account, emphasizing the importance of a robust emergency fund, particularly during the wealth-building phase. Finally, the podcast addresses the complexities of capital gains harvesting in a child's UTMA account to minimize the kiddie tax, weighing the potential tax savings against the effort required. Throughout, the hosts provide practical advice and considerations for various financial situations.
Outlines
Financial Foundations & Investment Strategies
This section introduces the "Financial Order of Operations" for managing personal finances (debt reduction, emergency fund, tax-advantaged accounts), and discusses strategies for Roth IRA contributions when approaching income limits, including dollar-cost averaging and the backdoor Roth.
Emergency Funds and Investment Decisions
This section debates the optimal balance between maintaining a large emergency fund and investing excess funds in an after-tax brokerage account, emphasizing the importance of a robust emergency fund, especially during wealth building.
Tax Optimization for Children's Accounts
This section explores the complexities of capital gains harvesting in a child's UTMA account to minimize the kiddie tax, weighing the potential tax savings against the effort and potential drawbacks.
Keywords
Financial Order of Operations
A step-by-step system for managing personal finances, prioritizing debt reduction, emergency funds, and then investments. Helps individuals systematically improve their financial health.
Roth IRA
A retirement savings account offering tax advantages. Contributions are made after tax, but qualified withdrawals in retirement are tax-free. Income limits apply.
Dollar-Cost Averaging
An investment strategy involving regular investments regardless of market fluctuations, reducing risk associated with lump-sum investing.
Backdoor Roth Contribution
A strategy to contribute to a Roth IRA even if income exceeds the direct contribution limits. Involves contributing to a traditional IRA and then converting to a Roth IRA.
Kiddie Tax
A tax rule affecting unearned income of children under 19 (or 24 if a full-time student). Income above a certain threshold is taxed at the parents' higher tax rate.
Capital Gains Harvesting
A tax strategy involving selling investments that have increased in value to realize capital gains. Can be used to offset losses or take advantage of lower tax brackets.
UTMA Account
A custodial account for minors, where an adult manages the assets for the benefit of the child. The child's income is generally taxed at the child's tax rate.
Emergency Fund
A readily accessible cash reserve designed to cover unexpected expenses, providing financial security during emergencies.
Tax-Advantaged Accounts
Investment accounts offering tax benefits, such as reducing taxable income or deferring taxes until retirement. Examples include Roth IRAs and HSAs.
Q&A
I feel like I'm behind on my savings. Where should I start?
Start today! Use the Financial Order of Operations to prioritize: 1) High-interest debt reduction, 2) Emergency fund (3-6 months of expenses), 3) HSA (if eligible), 4) 401(k) match maximization, 5) Roth IRA, then other investments.
How should I handle Roth IRA contributions when nearing income limits?
Consider dollar-cost averaging into cash until you determine your eligibility. Then, contribute the maximum either directly or via a backdoor Roth contribution (contributing to a traditional IRA and converting to Roth).
Is it wise to use emergency funds to invest in an after-tax brokerage account?
It depends on your financial situation and risk tolerance. Maintaining a robust emergency fund is crucial, especially for those focused on maintaining wealth. Consider this only after your emergency fund is well-established.
Are there downsides to harvesting capital gains in my child's UTMA account to stay below the kiddie tax?
It depends on the account size and turnover. The strategy can be beneficial if gains are significant enough to warrant the effort, but it's crucial to understand the kiddie tax thresholds and the hassle factor involved.
Show Notes
"Been watching Money Guy for a bit now. I'm having a hard time deciding where to start and I need to because I’m way behind. Eight percent going to 401a with an 8% match. I'm not sure where to put more - 457? Roth IRA?"
We'll walk you through that question and more in today's Q&A episode!
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