Five money myths you probably believe
Managing money can be complicated, and myths are often born from people鈥檚 struggles to make it simpler. But simplistic solutions can cost you instead of saving you money.
If you believe any of these five money myths, it鈥檚 time to take a closer look at the financial realities.
1. Myth: Everyone needs a fat emergency fund
Certified financial planners typically recommend clients have enough savings to cover expenses for three to six months. If you鈥檙e living paycheck to paycheck, though, it can take you years to amass that much.
Say you spend $5,000 each month and somehow manage to trim your expenses by 10%. To accumulate three months鈥� expenses ($4,500 times three, or $13,500), you would have to put aside every dime of that $500 savings for 27 months. Accumulating a six-month stash could take nearly five years. Either way, it鈥檚 too long to put off other important goals, such as saving for retirement and paying off high-interest-rate debt.
A better course: Shoot for a聽, which would cover small car repairs or an insurance deductible. Once you鈥檙e on track with retirement and debt repayment, you can focus on building up your savings.
Meanwhile, identify other sources of聽: items you can sell, nonretirement investments you can tap or low-cost ways to borrow, such as a home equity line of credit.
2. Myth: Getting married means higher taxes
Many couples don鈥檛 pay a聽聽鈥� and some get a marriage bonus, meaning their tax burden is lower because they married. That鈥檚 particularly true for couples with disparate incomes; together they pay less in tax than they would as singles.
Congress tried to eliminate marriage penalties for most taxpayers by expanding the 10% and 15% federal income tax brackets, which are twice as wide for married couples as for singles. In addition, the standard deduction for married couples is twice that for singles.
The couples most likely to pay a marriage penalty are those at the top and bottom of the income scale. The higher tax brackets aren鈥檛 twice as wide for married couples as for singles. At the lower-income end, couples that combine their incomes through marriage could lose some or all of the valuable Earned Income Tax Credit.
Even if you do pay a tax penalty, the cost is likely outweighed by the many other financial and legal benefits marriage provides.
3. Myth: Roth IRAs are a great way to save for retirement
Withdrawals from a Roth IRA are tax-free in retirement, and there are no required minimum distributions, which means you can pass unused money to your heirs, free of income tax. That makes Roths a pretty good deal for wealthier taxpayers and those who expect to be in a higher tax bracket when they withdraw the money than when they contributed it.
Many people, though,聽聽when they retire. They鈥檇 be better off taking a tax break now by making deductible contributions to 401(k)s and regular IRAs.
Of course, no one knows what future tax rates may be. If you want to hedge your bets, you can stash some money in a Roth IRA or Roth 401(k) in addition to making contributions to tax-deductible plans.
4. Myth: You should roll your 401(k) into an IRA
You definitely shouldn鈥檛 cash out a 401(k) when you leave a job, but聽聽into an IRA may not be the best option, either. You may be better off leaving your money in the old plan if it鈥檚 a good one, or transferring it to a new employer鈥檚 plan if that鈥檚 an option.
Financial services firms encourage rollovers because that means you鈥檒l be investing in their retail investment options, which cost more than the institutional funds found in many 401(k)s.
Your 401(k) account has other advantages:
- You can withdraw money penalty-free if you leave the company at or after age 55, while IRAs typically make you wait until 59陆.
- If you continue to work, you can put off withdrawals from your current employer鈥檚 401(k), while IRA withdrawals must start after age 70陆.
- You can鈥檛 borrow money from an IRA for more than 60 days without the withdrawal being taxed and penalized, but most 401(k)s offer loans that can last five years 鈥� and sometimes longer for a home purchase.
- Workplace plans also are better protected against creditor claims than IRAs if you鈥檙e sued or go bankrupt.
If any of these issues might affect you, consider leaving your money in a 401(k).
5. Myth: Scholarships will help reduce college costs
Scholarships can聽students get, leaving families no better off.
That鈥檚 because federal聽聽require colleges to ratchet back need-based aid when students win money from 鈥渙utside鈥� sources such as corporations, nonprofits and fraternal organizations.
Colleges have some leeway in how they implement these rules. The most generous may reduce the amount students are expected to contribute from their own earnings or lower the amount they鈥檒l have to borrow. Other schools that don鈥檛 fully meet a student鈥檚 financial need will allow scholarship money to fill the gap. Most, however, reduce grant aid dollar for dollar.
Affluent families who don鈥檛 qualify for financial aid tend to be the ones who benefit most from scholarships. If you have financial need, though, you鈥檇 be smart to ask about a college鈥檚 鈥渟cholarship displacement鈥� policy before you spend too much time applying for supposedly free money.
Liz Weston is a columnist at NerdWallet, a personal finance website, and author of 鈥淵our Credit Score.鈥� Email:聽lweston@nerdwallet.com. Twitter:聽.
This article was written by and was originally published by The Associated Press.
