David’s Personal Finance Q&A – January 2018

David’s Personal Finance Q&A - January 2018

David’s Personal Finance Q&A – January 2018

Through my work as a Certified Financial Planner™ I receive and respond to many questions throughout the course of a week. They come from clients, readers, colleagues, friends, family, and more. Some questions are general in nature while others are specific. Either way, there are still little nuggets of information that can be helpful to others. I’ll be sharing these questions and answers in this series called David’s Personal Finance Q&A.

Please note some of the questions have been changed around to protect the privacy of others. In addition, none of these responses should be considered investment advice. This Q&A is for educational purposes only. Please consult your own legal, tax, or financial advisor for help with your specific situation. I hope you find this helpful as you continue on your financial journey. Enjoy!

What is the five-year waiting rule for Roth IRAs?

The five-year waiting rule for Roth IRAs applies in two situations:

  • In order to receive a qualified distribution of earnings (not principal) tax-free, the withdrawal must not be within 5 years of the date of the first contribution. These time periods are governed by the beginning of the tax year for which the contribution applies as opposed to the actual date.
  • In order to receive a qualified distribution from a Roth IRA that was converted from an IRA without penalties applied to principal, the withdrawal must not be within 5 years of the date of the conversion.

There are other considerations to watch out for with Roth IRA Conversions. I wrote an article called Roth IRA Conversion – The Pro Rata Rule Is Lurking that goes into a little more detail.

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How can we grow our funds without a broker?

You may want to identify what type of financial professional is best equipped to address your needs. Working with a broker may be appropriate in some situations. However, your situation may benefit from working with a Registered Investment Advisor (RIA). Brokers and RIAs are very different in terms of services provided. In addition, RIAs are held to the fiduciary standard when working with clients. This means RIAs are required to put your interests ahead of their own.

If you’re more interested in investing without the help of any financial professional (broker or RIA), you can do that too. You can invest through a brokerage firm like Schwab, TD Ameritrade, or Fidelity to name a few. You can do this without having to work with a financial professional and you can direct all of your own transactions.

If you take money out of a retirement account, it will likely be subject to taxes and penalties if under age 59 ½. If you take money from a non-retirement account, you would be subject to capital gains taxes. However, if you have a loss, you won’t likely realize any capital gains to be taxed.

I would caution against investing in a single stock or even a small number of stocks. I wrote an article call Diversification Isn’t Enough which goes into more detail about the importance of diversification AND asset allocation.

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Is it safe to assume a market downturn?

The fact that stocks are at all-time highs doesn’t mean a downturn is around the corner. You list some valid concerns. However, regardless of the current level of the stock market, one should always assume that a downturn is possible. In any market environment (bull or bear) there can be cases made as to why the market is about to sell off or hit new highs. Unless you are day trading (which I don’t recommend), you should avoid trying to time the market.

If you have a long term investment plan and you decide to wait for a pullback, you might find that the market has run up another 5%. What do you do then? Wait even longer for a pull back? Remember, at the beginning of 2016 when the Dow was down roughly 10% at around 15,800, there were plenty of reasons to suggest the market would continue to drop. Sentiment can change and change fast.

To be sure, I’m not suggesting the market is set go higher or lower for that matter. I’m suggesting that timing the market can be risky and it’s best to let your time horizon, investment objective, and risk tolerance be your guide.

Should I be investing in sector ETFs or are they too volatile?

If you are generally risk averse, you should be very careful about investing in sector ETFs. Having said that, not all ETFs are alike and it depends on how narrow the sector is. If you stick with broad based index ETFs you’ll improve diversification at a low cost. Be careful. The more specific or narrow the sector, the greater the risk.

I just recently heard of HSAs. Would it be in our favor to get an HSA?

A little more information would be needed to determine if it would be right for your situation or if you are even eligible. To be eligible:

  1. You need to be covered by a high-deductible health plan (HDHP). If you’re not sure, contact the insurer to find out.
  2. You can’t have other health insurance coverage. This does not apply to insurance like disability, dental, vision, or long-term care.
  3. You can’t be enrolled in Medicare.
  4. You can’t be claimed as a dependent by anyone else.

If you’re eligible, an HSA is a great way to save for qualified healthcare expenses and has excellent tax benefits to boot. I write about this in more detail at Health Savings Account – Not To Be Ignored. I hope you find it helpful.

What happens to money left in a 529 account that was not used for educational expenses?

In general, if you use funds within a 529 for anything other than qualified higher education expenses, there will be taxes and penalties on the portion that is considered a gain. For example, if you have $10,000 left in an account and $8,000 represents your investment (or principal), you would be taxed and penalized on the $2,000. You could designate another beneficiary. If spend the 529 funds on the new beneficiary’s education expenses you will avoid the taxes and penalties. Otherwise, you can access the funds, but you will likely incur taxes and penalties to do so. I wrote in more detail about savings for college in my article UTMA Accounts – Planning For College.

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