Six Money Rules You Can Break

Stacks of coins and pile of bills.

For most people, following basic money rules makes sense. But like everything else in life, there are situations when following tried-and-true advice might not work. Our professionals weigh in on when to consider the exceptions.

Rule No. 1: Pay off debt and build an emergency fund before saving for retirement.

Saving enough money to pay three to six months of living expenses will lessen the chances you'll have to sell assets or go into debt in case of an unexpected big-ticket expense or job loss. J.J. Montanaro, a certified financial planner ™ practitioner at USAA, says building this emergency fund -- in something safe and liquid, such as a savings account -- should be a top priority, along with paying down any high-interest consumer debt.

When to break it: If your debt is of the low-rate, tax-reducing variety, such as a mortgage or student loans, and your retirement plan at work offers a match, you might be better off contributing enough to receive the full company match before focusing on building your emergency fund and eliminating debt, says Montanaro.

Remember that contributions to a traditional employer-sponsored retirement account, such as a 401(k) or Thrift Savings Plan, may reduce your tax bill. Add the money from your employer match, and you've got a hard-to-beat combination. If you don't participate in these plans, you could be missing out on valuable benefits and tax savings.

Rule No. 2: Save up to 10% of your income.

Contributing at least $1 to your savings (or 401(k) or TSP) for every $10 you earn -- or 10% -- is an old rule of thumb. And it's certainly better than the current national savings rate.

When to break it: If you didn't begin saving for retirement until you were in your 30s or older, it may take more effort to achieve your retirement goal.

"A late start means you've probably got ground to make up, and 10% is probably not enough to close the gap," Montanaro says. To find out how much you need to save to meet your financial goals, use USAA's online calculators.

Rule No. 3: Always max out your employer-sponsored account.

If you need to increase your retirement savings and are not already contributing the maximum amount allowed to your 401(k), a reasonable reaction is to immediately boost your contribution rate.

When to break it: To create a better tax-management plan, you may need to look beyond your employer's plan.

"If you don't have a Roth 401(k) available, you may be better off contributing just enough to take full advantage of a match (if your employer offers one), but then sending additional savings to a Roth IRA, if you're eligible," says Scott Halliwell, a certified financial planner ™ practitioner at USAA. A Roth contribution won't lower your tax bill today, but the possibility of qualified, tax-free withdrawals during retirement is a benefit.

"You'll likely have control over future income tax bills by having money in pretax and Roth accounts," adds Halliwell. What if your income exceeds the IRS limit for making Roth IRA contributions? Consider opening an after-tax traditional IRA and converting it to a Roth. Since 2010, income is no longer a factor in Roth IRA conversion eligibility. Conversions from a traditional IRA to a Roth are subject to ordinary income taxes. Please consult with a tax adviser regarding your particular situation.

Rule No. 4: Send your kid to college -- it's a great investment.

Yes, the average college graduate earns $26,618 more a year than someone with just a high school education, according to the U.S. Census Bureau. As a result, most financial planners agree that helping your child get a college education is important.

When to break it: If helping pay for your child's four-year college degree places an extreme burden on your finances, you should consider other, more affordable ways to accomplish this goal.

The return depends on the price you pay and where that money comes from. The nonprofit research group Project on Student Debt reports two-thirds of college seniors who graduated in 2011 had student loan debt, with an average of $26,600 per borrower.

To avoid overpaying for a diploma, Montanaro suggests looking for cost-effective ways to get an education, such as spending the first two years at a community college, then transferring to a four-year college. For 2012-13 enrollment, annual tuition and fees at a community college cost an average of $3,131, compared to in-state tuition of $8,655 for public four-year colleges and $29,056 for private universities, according to the College Board.

Rule No. 5: Buy a house if it costs 2.5 times your annual income or less.

This is a reasonable guide when determining whether you can afford to buy a home.

When to break it: If it doesn't suit your circumstances, disregard this guideline.

What really matters is whether you can afford the monthly payment, factoring in taxes, insurance, maintenance, current mortgage rates and the size of your down payment. Plus, consider how long you'll live in the house. If you plan to move in a few years, renting may be the better decision.

Rule No. 6: When you retire, consider a withdrawal of 4% of your portfolio, then adjust every year for inflation.

Historically speaking, the so-called 4% rule calls for a retiree to make annual inflation-adjusted withdrawals and be reasonably sure the portfolio will last 30 years. For most retirees, it's a fine starting point to determine how much they can spend.

When to break it: Your plan for retirement is not a smooth glide path.

Retirees may prefer withdrawing more in good times and cutting back when times get tough, or varying distributions based on their investment results. Also, adjustments should be made according to other sources of income. For example, Montanaro says some retirees may wish to withdraw more at first and delay taking Social Security, but then withdraw less once the Social Security benefit kicks in. "Whatever your plan, it should be monitored and adjusted as necessary," he says.

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