Managing money can be complicated, and myths are often born from people’s struggles to make it simpler. But simplistic solutions can cost you.
If you believe any of these money myths, it’s time to take a closer look at the financial realities.
Myth 1: 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’re living paycheck to paycheck, though, it can take you years to amass that much.
A better course: Shoot for a starter emergency fund of $500, which would cover small car repairs or an insurance deductible. Once you’re on track with retirement and debt repayment, you can focus on building up your savings.
Myth 2: Getting married means higher taxes.
Many couples don’t pay a marriage penalty — and some get a marriage bonus, meaning their tax burden is lower because they married. That’s particularly true for couples with disparate incomes; together they pay less in tax than they would as singles.
Even if you do pay a tax penalty, the cost is likely outweighed by the many other financial and legal benefits marriage provides.
Myth 3: 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.
Many people, though, will be in a lower tax bracket when they retire. They’d be better off taking a tax break now by making deductible contributions to 401(k)s and regular IRAs.
Myth 4: you should roll your 401(k) into an IRA
You definitely shouldn’t cash out a 401(k) when you leave a job, but rolling your account into an IRA may not be the best option, either.
- Advantages to keeping a 401(k) account include:
- You can withdraw money penalty-free if you leave the company at or after age 55, while IRAs typically make you wait until 59 1/2.
- If you continue to work, you can put off withdrawals from your current employer’s 401(k), while IRA withdrawals must start after age 70 1/2.
- Workplace plans are better protected against creditor claims than IRAs if you’re sued or go bankrupt.
Scholarships will help reduce college costs. Scholarships can reduce the amount of financial aid students get, leaving families no better off.
That’s because federal financial aid rules require colleges to ratchet back need-based aid when students win money from “outside” sources such as corporations, nonprofits and fraternal organizations.
Colleges have some leeway in how they implement these rules. If you have financial need, you’d be smart to ask about a college’s “scholarship displacement” policy before you spend too much time applying for supposedly free money.