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Former WSJ columnist gives advice to iwillteachyoutoberich readers

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While I was in New York a few weeks ago, I stopped by to meet Jonathan Clements, the former columnist for the Wall Street Journal — which I thought was the best personal-finance column in the country. (Here’s one of his columns: Twenty Tips for No-nonsense Investing.)

Jonathan Clements

Jonathan is now the director of financial guidance at MyFi. While I was there, we chatted for almost two hours (he’s hilarious) and I asked if he’d be willing to write up his thoughts on the most important step for iwillteachyoutoberich readers. Here’s what he had to say.

There’s no debate over the top priority. If you’re new to the work force, you ought to be funding your employer’s 401(k) plan, because it will give you a trio of benefits: an upfront tax deduction, tax-deferred growth and maybe a matching employer contribution.

But that brings us to the more interesting question. What should your no. 2 priority be? Forget building the six-month emergency reserve or saving for a house down payment. Instead, I would vote for funding a Roth IRA.

With a Roth, all your withdrawals once retired should be tax-free. True, unlike a regular IRA, a Roth won’t give you an initial tax deduction. But if you’ve just entered the work force and you are on a relatively low salary, that tax deduction probably isn’t worth all that much.

Meanwhile, here’s the sweetener: At any time, you can withdraw your original Roth contributions without triggering taxes and penalties. Let’s say you stash $5,000 in a Roth every year for four years. You could pull out your $20,000 in contributions and, provided you didn’t touch the account’s investment earnings, there shouldn’t be any taxes owed.

That means your Roth could double as your emergency reserve, your house down payment money, your car purchase fund or be used for any other purpose. (There is another provision that allows first-time homebuyers to make tax-free Roth withdrawals. To take advantage of this, the Roth has to be open five years and the amount is limited to $10,000.)

Ideally, you would leave your Roth to grow untouched until retirement. That way, you’ll get the most out of the tax-free growth. But if you
need it, the Roth offers wonderful financial flexibility. To learn more, head to www.fairmark.com.

I’ve written about Roth IRAs and 401(k)s in The World’s Easiest Guide to Retirement Accounts.

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42 Comments on "Former WSJ columnist gives advice to iwillteachyoutoberich readers"

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David
David
8 years 5 days ago

What’s step #3? Have the emergency reserve?

I know exactly what I spend (track it monthly), spend less than I make, , have no debt, save ~40-50% of my paycheck, max out my Roth and 401k, have 2 years of Emergency cash assuming my spending is the same, etc.

I guess I should start optimizing my ROI? That’s where I’m stuck. What next? I feel like I’m in a financial standstill. I’m doing the right things, it seems, but how can I do more?

Tom
8 years 5 days ago

I am kind of surprised that he didn’t suggest creating an emergency fund as your second option. With a Roth IRA you can’t take the money out without big deductions until you reach retirement. A lot of younger people with new jobs usually have big expenses to start (i.e. ring, house or rent payments, car payments, etc.). It’s kind of hard to argue, especially with his background.

Alex
Alex
8 years 5 days ago

If you withdraw money from your Roth IRA as an emergency fund can you put the same amount back in at a later time? My understanding is that you can only put in 5k per any year. Say you withdraw 15k for an emergency but can only put back in 5k a year, aren’t you effectively sabotaging this retirement fund?

Moneymonk
8 years 5 days ago

I miss Johnathan Clements

Daniel
8 years 5 days ago

Really. I have had a Roth since I was 16 (now 26). My wife and I are facing some big expenses (like Tom said, rings, wedding, and down payment). Ramit, you might have to say it again. You withdraw the principal at anytime — tax-free and penalty-free?

I heard of $10,000 for a home but, never heard of anything else.

Jonathan
Jonathan
8 years 5 days ago

Any thoughts on the new MyFi program? I’m skeptical, but with Clements there, I’d be willing to give it a look.

Carlo
Carlo
8 years 5 days ago
Using a Roth as a replacement seems for an emergency fund seems like a great long-term idea, but I’m not so sure if it would work as well in a short-term window. For example, my investment of $20K over 4 years may be significantly lower if the market happens to suffer during that time period. Of course, having a longer period of time to ride out the ups and downs would be best, but it’d be a tough pill to swallow if my house deposit savings were less than what I initially put in the Roth. Just my two cents… Read more »
anotherguy
anotherguy
8 years 4 days ago

Honestly….i dont know if im messing up my future…but i say screw 401K. im doing it the traditional way of saving after tax money. im 32 and so far my net worth is a little more than $500K. 2 cars both paid off. house paid off.

401K : zero

Romit
Romit
8 years 4 days ago

What about non US citizens? 401s and Roths are not for us.

Russ
8 years 4 days ago

I’m surprised to see Clements associated with MyFi, a division of Citi Smith Barney.

I’ve always enjoyed his WSJ columns and remember him consistently encouraging readers to seek the help of fee-only, fiduciary advisors. Due to the regulatory environment, there is no way anyone associated with Citi Smith Barney can operate as fee-only or as a fiduciary. This seems counter to his past advice and writing.

Interesting . . .

Jonathan B.
8 years 4 days ago

This sounds good but what if your stocks are not doing so hot? For example, if you invest $5,000 in a bad year and your balance goes down to $4,500. If you decide to withdraw that $4,500, then your balance is effectively $0, no? I’d rather leave my IRA alone and just pile up some savings in a money market.

Derek
Derek
8 years 4 days ago
Hi Ramit, I’m 24, have been working for a year at my first salary job, and my employer offers a Roth 401(k). I recently stopped contributing to the regular 401(k) and now put 6% into my Roth 401(k) (They match 50% up to 6%). Since Roth 401s relatively new I haven’t seen or heard much about them, but I have to assume you’re getting the benefits of a Roth IRA with the match of a 401. Their match goes to the traditional 401 for tax reasons but my retirement withdrawls will be tax free when I’m in a higher tax… Read more »
Natalie
Natalie
8 years 4 days ago
Wow! To think that I hadn’t heard of this tax-free withdrawal of Roth IRA contributions. I read an entire pamplet a few years ago regarding the Roth IRA and somehow through all the convoluted language (or simply my own inability to read and comprehend) I missed this. How wonderful! I just rearranged my budget and now it looks like it will be possible for me to fund almost my entire 401(k) – no company matching unfortunately – as well as fully fund my Roth. Thanks so much! If a number of readers on your blog didn’t know this, I’m afraid… Read more »
ekrabs
ekrabs
8 years 4 days ago
His advice is what I typically recommend as well. However, the devil is in the details, and to get the most out of you buckets, you’ll want to look at everything closely. For example, some 401k offer no matching and the few funds frankly stink. In cases like that, it may actually be worth funding your own IRA instead. Roth IRA is excellent, but it works best if you can get yourself in the 15% income bracket. Anything higher, and you may want to consider a traditional instead, or end up paying more taxes than you have to. Also, you… Read more »
ekrabs
ekrabs
8 years 4 days ago
Derek, I’m not ramit, but if you don’t mind me taking a stab at it, it really depends on what income tax bracket you think you will end up in later in your life as opposed to what bracket you are not. If you are in the 25%, it can go either way, but if you are in 28%, I’d definitely focus on the regular 401k instead. While we may not know what bracket we may be in later in life, I think most of us can figure out a way to get ourselves into lower tax brackets, wouldn’t you… Read more »
ekrabs
ekrabs
8 years 4 days ago
A quick clarification about the Roth if I may. The Roth is not actually tax-free in the sense that you will never pay taxes on it. It’s tax-free in the sense that you don’t have to pay taxes on it LATER because you’ve ALREADY paid the taxes for it. But because it’s already taxed, that’s why it offers so much flexibility, because that money is basically yours to do as you please. Uncle Sam has already taken his cut. Still, if you’re in a high income bracket, the Roth could actually be worse off than a traditional. For example, it’s… Read more »
Mark Nelson
8 years 3 days ago

I don’t agree with using your Roth as your emergency fund. Maybe some people are disciplined but many people once they pull their funds from the Roth will have a hard time putting them back.

You need a separate emergency fund.

topseekrit
8 years 3 days ago

This is exactly what I needed, I’m getting ready to roll over my 401K from my former employer into a Roth IRA. Is this a good move? Any advice? I totally forgot that you can withdraw your principal amount from your Roth IRA. Thanks for the post!

Odd Lot
8 years 3 days ago
The Roth IRA is definitely one of the best ways to save money but I think people will miss the point of a Roth if we say one of the major strengths is that you can withdraw your principal at any time without being penalized. Granted, it’s a benefit but don’t Americans already have way too much trouble with the discipline of saving in general? I think we should be pushing the fact that you won’t be taxed at retirement instead but I guess whatever gets people to invest in save is winner… even if you have to tell them… Read more »
Joe
Joe
8 years 3 days ago

ekrabs, Derek, Ramit,

One thing that seems to be glossed over is that when you contribute to a Roth IRA or Roth 401k, you are taxed at your highest marginal tax rate. If you contribute to a traditional 401k, when you withdraw the money in retirement, it will be taxed progressively. For instance, if your income was 40,000 you would be taxed at 25% for the roth and for traditioanl, if you withdrew that amount as your only income you would be in the 25% tax bracket but only pay 14% of that sum as tax.

ekrabs
ekrabs
8 years 3 days ago
Thanks for point that out Joe. Didn’t mean to gloss it, but that’s why I use my 401k to not only get my match, but to also get myself into the 15% bracket. After that, it’s pretty much a non-issue. That’s also why people need to be aware of which bracket they’re in when considering which retirement accounts are the best for them to use. But just so it’s clear, the Roth isn’t always taxed at its highest marginal rate. However, it may seem like it if you’re making $40k, because your entire $5k contribution would seem like it lands… Read more »
Tage
8 years 2 days ago

You bring up a good point. Why fund an emergency fund that may only net 4% in a great online account, when it could be earning 8-10% in a ROTH.

Besides, interest on the online bank account will be taxed. Nice call, didn’t think like that before. Thanks.

Tage
8 years 2 days ago
@Ekrabs I believe the longer you hold a a fund, you should lean more towards ROTH? If you invest for 25 years, that means 25 years worth of profits that will be taxed. If it was ROTH, only original contributions will be taxed. If you invested $500/month for 25 years, that would be 150k invested. Interest at 8% would be almost 330k on top of that 150k. With a regular IRA, you would have to pay taxes on the entire 480k. Let’s say you do have a lower paying job, and are only taxed 15%. That’s still 72k in taxes.… Read more »
ekrabs
ekrabs
8 years 2 days ago
Tage, I understand your premise, but because you’ve already lost money (opportunity cost) on the taxes that is already paid on the Roth, that’s money you won’t be able to use or grow. The only difference is that you don’t see the tax penalty as clearly with the Roth as you would with the traditional. Does that make sense? A more artificial but clearer way of looking at it is to pretend that you’re young and you make only 1k. Out of that 1k you made, you got taxed 10%, so you’re left with $900. So, in reality, that’s only… Read more »
Tage
8 years 2 days ago

Ah, yes that makes sense as well. Luckily, it shouldn’t be that hard to max your Roth, and max out your 401k up to the point where you get your employer match. But it does seem a lot more complicated than just a surface look. Thanks!

Jared
8 years 2 days ago

Great point on the Emergency fund. I contribute to my Roth IRA regularly instead of saving for a house. My money grows a lot faster in that account compared to a savings or CD, even in this turbulent economy It’s done alright.

William Bay
8 years 8 hours ago
If you view your retirement fund as a way out in an emergency, it blurs the line. My wife and I are just starting our path to financial freedom – 15,000K in debt, two cars, and a mortgage. And if I were to allow ourselves to blur the line there, than whose to say the blurred line can’t extend to using credit cards when they’re paid off. Here is why this doesn’t work (respectivley of course): 1. No matter how you look at it you are extending your debt. You are in debt to yourself – but you’re still in… Read more »
William Bay
8 years 8 hours ago
Off topic but… As far as the ROTH vs Trad IRAs here are some numbers: Say you invest $2,000 each year into each ROTH and Trad: You invest to 30 years and you are able to get 12%/yr compounded monthly. At the end you would have a lump sum of $660,218.25 But with the ROTH you would have to earn $3,000 to make the $2,000 contribution (assuming 33% tax bracket). Which means that you have paid $30,000 in taxes spread out over 30 years. Which whittles down your net worth to 630,218.25. With the Trad you will end up paying… Read more »
Jeremy Freelove
Jeremy Freelove
8 years 5 hours ago

@William:

Your analysis is incorrect because you ignore the Time Value of Money on the taxes for the first 30 years. As you mention, “with the ROTH you would have to earn $3,000 to make the $2,000 contribution (assuming 33% tax bracket)”, but you ignore the potential earnings of that additional money in the traditional IRA. If you compound this amount at the same rate, you’ll see that the two accounts end up being exactly the same.

Therefore, the only difference in analysis should be the current and expected tax brackets that you will be in.

Carlin
Carlin
8 years 4 hours ago
I think if you use an emergency fund for major emergencies (medical bills, job loss, major repairs, etc) then you shouldn’t really have to make withdrawals that often since these items aren’t likely to happen often, and in this case using the Roth this way is a great idea, plus using it to save for a house is nice too if you’re saving over a longer time period. I think a separate savings account or something that had $2,000 or so in it for the more minor emergencies (miscellaneous car repairs, smaller medical bills, home repairs, unexpected taxes, etc) would… Read more »
William Bay
7 years 11 months ago
Jeremy, At the risk of hijacking the post, I’ll try to keep this short. I see your point, and you would make a considerable amount more not equal amounts. Like 200,000 more. But I’m talking about equal amounts invested. Say you invest the maximum amount of $5,000… ROTH you must invest $6,650 for a total of $5,000 ($1,650 in tax every year at a total of $49,500). TRAD $5,000 for $5,000 (no tax – and you can spend the extra money on bubble gum – something as useful as the IRS) At the end of 30 years at 12% you… Read more »
ekrabs
ekrabs
7 years 11 months ago
William, all else being equal, the amount you’ll end up with is the same regardless of which vehicle you choose. But the key here is “all else being equal”, which I realize is arbitrary, but it’s the only way to realize that both vehicles use the same income tax brackets. The first example you have provided is slightly confusing in that you have chosen the Roth to be in the 33% bracket whereas you have chosen the Traditional to be in the 15%. While something like that (not 33% but maybe 28%) can Very Much happen in real life– and… Read more »
Writer's Coin
7 years 11 months ago

I remember reading him back in the day. Plus a story he wrote about 401(k)s somehow got linked to a post of mine and gave me my very first spike in traffic last year.

I agree that the Roth and the Em fund should be separated if at all possible. Otherwise you don’t really have an emergency fund, you have an “I’m risking my future retirement well being” fund.

Keith
Keith
7 years 11 months ago
I find this interesting because I recently took a distribution on my Roth contributions. So, I’m glad I knew of this option but I was confused with some questions asked by the company (a major one) who services my account. When finishing the transaction over the phone, they asked me if I wanted to tax the amount now or handle it at tax time. What? I said no, send me the full amount requested. I called back a few days later to gain some clarity. The rep said they are required to ask the question about taxes. Okay, fine I… Read more »
Brennan
8 months 12 days ago
Cash it out. Insurance is not an investment.You’re not mareird, and you don’t have any kids.So who needs the money from the life insurance policy if you die?You are stating two different goals for your money, so you’ll need two different accounts.1) Your own investments. The Roth IRA is the way to go.2) Children’s college fund. Look into a 529 Plan , but your IRA is for your retirement. Your kids’ degrees won’t put food on your table when you’re 65.If you get mareird and have kids, then you can look into buying another life insurance policy. But term life… Read more »
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3 months 28 days ago

One company that I worked for paid you for unused time at the end of every year. That was great because the check came two weeks after New Years.These debates something about the state of employment these days. I remember when the city was broke and the contract solution was to force a strike and pay for the new contract with money saved from not paying picketed workers. Workers on the picket line knew that the strike was an investment in future workers/contracts. I also remember when vacation time was given in lieu or raises.

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3 months 28 days ago

mmm, îmi pare rău, dar nu am primit nimic, problemuțe tehnice, administrative la care eu nu mă prea pricep, dar mulțumesc pentru orice ai fi zis acolo

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