Smart Money Podcast: Pandemic Money Lessons, and Saving for a Down Payment

Sean Pyles, Liz WestonDecember 7, 2020
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Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions.

This week’s episode starts with a discussion of some of the money lessons we’ve learned during the pandemic.

Then we pivot to this week’s questions from Shannon, who asks, "How much of my savings should I try to put in retirement accounts versus saving for a down payment on a house? Is there an advantage of contributing to an IRA versus a 401(k) if I don't have any company match? And can a traditional IRA convert to a Roth or would I need to open new accounts for this?"

Have a money question? Text or call us at 901-730-6373. Or you can email us at [email protected]. To hear previous episodes, go to the podcast homepage.

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Our take

Saving for retirement should be most people’s top priority, but that shouldn’t exclude other financial goals. If you’re saving 10% to 15% of your income for retirement, you’re probably in good shape. Someone who’s young and saving 20% for retirement likely can cut back on those contributions and put more into saving for a down payment, for example. The amount you put toward each goal will depend on a number of factors, including how big a down payment you’re shooting for and when you want to purchase a house.

Deciding how to save for retirement also depends on your individual circumstances. IRAs typically offer more investment options and flexibility if you need to withdraw money. But you can contribute more to 401(k)s and borrow from them if necessary, and most plans offer matches to sweeten the deal.

If your employer offers a 401(k) match, then your first step should be scooping up that free money by contributing enough to get the full match. After that, you could consider contributing to a Roth IRA if you can. Roths don’t offer a tax break on contributions, but withdrawals in retirement are tax-free. Many financial planners recommend having at least some money in Roth accounts so that you can better control your tax bill in retirement.

If your 401(k) doesn’t offer a match, you may still want to contribute because those contributions are tax deductible. Your contributions to a traditional IRA may or may not be deductible, depending on your income. If you want to contribute to an IRA but your contributions aren’t deductible, consider contributing to a Roth IRA instead since your withdrawals in retirement won’t be taxed.

If your income prevents you from contributing directly to a Roth, or you want to put more in than the current $6,000-per-year limit, you can convert money from a traditional IRA, but that typically requires paying taxes.

Roth conversions may be worth the cost if you expect to be in the same or a higher tax bracket in retirement and you can pay the tax bill without dipping into your retirement savings.

Our tips

Balance your priorities. Saving for retirement is important, but so is achieving other life goals like buying a house.

Optimize your retirement savings. Get the full 401(k) match if your company offers one. After that, balance current tax breaks on contributions and future tax breaks on withdrawals.

Work backwards. Know how much you'll need for a home down payment and closing costs and how much you can save monthly to get there. Adjust as necessary to find the right balance between saving for retirement, a down payment and current expenses.

More about balancing financial goals on NerdWallet:

Sean: Welcome to the NerdWallet's Smart Money podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. I'm Sean Pyles.

Liz: And I'm Liz Weston. To have your money questions answered on a future episode, call or text us on the Nerd hotline at 901-730-6373. That's 901-730-NERD, or email us at [email protected].

Sean: And hit that subscribe button to get new episodes delivered to your devices every Monday. And if you like what you hear, leave us a review.

Liz: This episode, Sean and I answer a listener's question about how to balance saving for a down payment on a house while saving for retirement. First, though, in our this week in your money segment, Sean and I talk about the money lessons that we learned this year.

Sean: Yes, after weeks of asking for your money lessons from this year and receiving some really thoughtful responses, which we'll be sharing in an episode later this month, Liz and I figured that we should share what we learned this year, too. I know that I have a pretty notable lesson, but Liz, I'd love to hear what you learned this year too.

Liz: Well, I learned two things and they're kind of related. And the first one was how important it is to build some slack into your personal economy. And that can take a number of different forms. Everybody's talking about emergency funds and how important emergency funds are. I've written a column, a few different versions of it, basically about the emergency fund you can eat, meaning having a good store of pantry supplies. And now we've learned you also need toilet paper and paper towels and Clorox wipes and those other things.

But just understanding that most of the way that the economy is set up is a just-in-time economy. So products arrive at the grocery store right before you buy them. And the pandemic showed the cracks in that system. I’m thinking more about how to be even better prepared. And I'm a big preparer, I like to be prepared — but build even more slack if possible.

And the related thing is that there are a lot of people who just cannot do that, that are just not in a good position to be able to build in slack. So I noticed in our particular neighborhood, people were reaching out to help each other. Sometimes it was really something stupid or small like my neighbor had an Easter ham and she really wanted to make split pea soup. And she had no split peas. Because I'm a bit of a prepper — I really worry about that phrase prepper — but because of that, I had a bunch of split peas I could give her and that felt great. And other neighbors were reaching out to do grocery shopping for each other. And it was just really nice. So I guess the big lesson is we need to build slack into our personal economies, and we also need to reach out to others to make sure that everybody's taken care of.

Sean: Help those who don't have as much slack in their personal economy.

Liz: Yeah. And even if you are missing something or need something, try your neighbors first, try your friends first because that's probably a great place to turn to.

Sean: I've been pretty impressed by how mutual aid has been one of the key words this year with people just reaching out to see how they can help others, whether it's folks who were sending money in to a bail fund, for people who have been protesting and have been unjustly arrested, or even in my neighborhood in Portland, there are little pop-up pantries where people will put their older cans out or just food that they know they're not going to eat, but they figure someone would probably benefit from, they put it there.

It's almost like a neighborhood library but for food, and they're all around town. And it's great because food banks actually don't really want your canned stuff. It's not great to have an old thing of cranberry sauce that you've had forever and just giving it to them. But there may be someone locally who would benefit more from that.

Liz: I think people don't understand that the food banks would really rather have money because they can make that go a lot farther. They get deals with the fruit producers so they can use that a lot better than they can use that can of old cranberry sauce.

Sean: Right. Well, my money lesson is kind of related to yours in a way, because mine was that 2020 has showed me the power and the limits of self-discipline. Similar to yours, it showed me how there are a lot of things that you can do for yourself if you have the means to do it. Here's how that kind of worked out for me.

I set out this year with a pretty ambitious savings goal. I wanted to save $10,000. It was a kind of pie in the sky figure that I ended up achieving actually.

Liz: Oh, congratulations.

Sean: Thank you. I had a few goals behind it. My why behind the $10,000, I wanted to cut frivolous spending. I wanted to really get serious about saving because that's something that I'd always been OK at but never really focused on. And that was in part to build up my emergency fund and save up for a down payment on a house.

The thing that I learned that's really hard about self-discipline is that it turns out that you have to do it yourself, which sucks. I had to figure out ways to make myself be disciplined and also make that easier for myself. With savings, I just automated a not-insignificant portion of my income to be directly deposited into my savings account. And I found that made it really easy because it meant that I was working with less in my checking.

I mentally was not allowing myself to touch my savings and I could just build on that month over month. And then if I had anything left over in my checking at the end of a pay period, I would just transfer that over as well. So between that and not going out, not traveling and the check that we received in the spring from the CARES Act, I was able to hit that goal, which was pretty miraculous. I never thought I'd be able to do that, but I did. And I'm pretty proud of myself for it.

Liz: Yeah, absolutely.

Sean: I realized that as much as my ability to save this amount was a result of hard work, it's also a reflection of the really privileged position that I was in this past year. I know that a lot of people weren't able to do that. This kind of gets back to the whole bootstrapping, latte-forgoing idea of personal finance, where if you just stop having that avocado toast, you'll be a homeowner in a year.

We know these things aren't realistic and this gets to the limitations part of it. The pandemic showed all of us how fragile our lives are. And even in my own household, I was in a place where I was able to save more in part because I wasn't going out and I received a promotion this year.

Liz: Congratulations.

Sean: Thank you. But at the same time, my partner was working fewer hours and received reduced pay for a significant portion of this year. And Garrett was always the saver and he helped inspire me to get my act together. But this year he wasn't able to do that. Even though we have pretty similar backgrounds and are very, like, white-collar workers, the whole economy is very fragile. Our personal economies are very fragile.

So it made me appreciate the position that I was in and realized that you know, there, but for the grace of Dolly Parton go I — a lot of people are having a hard time. And I think that we need to appreciate the opportunities that we have to meet these goals and realize that not everyone has that.

Liz: And when you do have a little bit of slack or a little bit of extra, it's so important to pass that on in whatever way you can.

Sean: For me, that means putting up monthly contributions to causes that I care about, putting a can of soup or a cranberry sauce, I just don't like cranberry sauce, so I'm passing that on that people in my neighborhood.

Liz: You need my recipe, honestly.

Sean: Just doing what we can to help people, because we know that so many people don't have that opportunity. Eight million Americans were pushed into poverty as a result of the pandemic, and it's getting worse by the day. So, not to be a total downer about this, but it also gives me hope that in the new year, we can all appreciate what we have and extend support to those who have less and push people who can make these decisions to provide more aid for people who are struggling the most.

Liz: Because a lot of it is expiring on Dec. 31 and that's really scary. So let's hope the Congress can get it together to extend some aid as soon as possible.

Sean: Thinking of back to the beginning of this year, what a wild ride that was, it feels like many, many years ago at this point. And I honestly wasn't sure I would be able to achieve that $10,000 goal. I'm really happy that I did. I was able to make some big moves as a result of that. It makes me wonder what could happen next year. It makes me excited for it, it also makes me a little bit scared, I'll say.

Liz: Looking ahead it's what is 2021 going to look like? Nobody knows.

Sean: Well with that, how about we move on to this week's money question?

Liz: All right.

Sean: This episode's question comes from Shannon, who writes: "Hi, I have a question about retirement savings. I currently have an employer-sponsored 401(k) without a company match. I contribute 12% into this account. I was recently hearing about IRAs from a coworker and decided to open one as well. To max out on my IRA, $6,000, plus the 12% going into my 401(k), that would mean that I would be contributing a total of 21% of my income into my retirement accounts.

“I'm 30 and we'd like to buy a house at some point. I'm in SoCal and the prices are so atrocious, but it's difficult to contribute that 21% to my retirement accounts plus enough to save for a down payment. So here are my questions: One, how much of my savings should I try to put in retirement accounts versus saving for a down payment on a house? I currently have a six-month emergency fund saved. I was trying to max my retirement accounts out, but it didn't leave me with much left over to save for a down payment.

“Two, should I max out my IRA each year, but contribute less to my 401(k)? Is there an advantage of contributing to an IRA versus a 401(k) if I don't have any company match?

“And three, on a recent episode, you spoke about having both Roth and traditional accounts. Can a traditional IRA convert to a Roth or would I need to open new accounts for this?"

Sean: That was a mouthful.

Liz: Shannon. I love you. You're awesome.

Sean: This is the ideal question that we want on the show. It's so detailed, so specific, and it shows that you really know how to manage your money. So kudos, Shannon.

Liz: Yes, absolutely.

Sean: So to help us answer Shannon's excellent three-part question, Liz and I are going to talk with investing Nerd Chris Davis. And before we get into this question, a quick disclaimer. Liz, Chris and I are not financial or investment advisors, and we won't tell you what to do specifically with your own investments, but we can provide the Nerdy info you need to understand the factors that would go into making your own investment decisions. All right, now let's get into the conversation.

Liz: Hey, Chris, welcome to the podcast.

Chris: Hey, happy to be here.

Sean: So good to have you, first-time guest.

Chris: Longtime listener, though.

Sean: As you heard in that lengthy question or a series of questions from Shannon, she wants to save for a down payment on a house, but is also very focused on saving for retirement. And in fact, I don't know if this is controversial to say this, but I think she might be saving a little bit too much for retirement. So is there a general rule of thumb about how much someone should be saving for their retirement?

Chris: Yeah, there is a very general rule, we could say 10% to 15% of your pre-tax annual income could be earmarked for retirement. Again, that's really going to change for everyone, but if you have no idea where to start, that could be a good place.

Sean: And what would make someone want to contribute 10% versus 15%? Is it income, life expectancy? What are the factors to consider here?

Chris: I mean, there's a lot of factors. It would be your income compared to your current spending and saving habits. Life expectancy is also one of them, for sure. And how much you might spend in retirement as well — that's a big consideration.

Liz: I want to put a pitch in here for our retirement calculator. We have it on the site and it can really help you fine-tune some of these issues. And generally speaking, if you haven't started saving for retirement and you're in your 40s or heaven forbid 50s, 20% probably is what you need to save. If you're younger and you're not planning to retire early, then you should be saving and you should be saving aggressively. But maybe not that aggressively.

Sean: That's what I was thinking as well. This seems like an instance where maybe Shannon's over-ambitious saving for retirement is limiting other things that she might want to accomplish, like saving for that down payment on a house. Well, let's get onto another question that Shannon had, which is whether it may be better to contribute more to a 401(k) or to an IRA.

And again, this is just general advice around contributing to these different kinds of accounts. So how do you think about weighing whether it's better to contribute to one versus another?

Chris: Sure, it depends on a couple of factors again. I think the biggest one is if your employer offers a 401(k) matching program, that's a great incentive to invest in your 401(k) first. So if your employer matches up to 4%, say, consider contributing 4% to that 401(k).

Liz: Should you limit it to 4% though?

Chris: You could consider contributing more. But at the very least, I think it makes sense to get that match because that really is free money. And it's great to take advantage of that.

Liz: Where this gets tricky is when you have a 401(k) at work, but you don't have a match. You can contribute to an IRA instead, but the contribution might not be tax-deductible. It depends on your income, so you'll want to find that out. It may be worthwhile to contribute to the 401(k) anyway, if you get the tax break there and you wouldn't get it with an IRA. Although there are some benefits to IRAs, right, Chris?

Chris: You tend to pay less in administrative fees with an IRA compared to a 401(k). And you also have some more flexibility in a few different areas. You'll likely have a bigger investment selection in your IRA, you'll even have a little bit more flexibility in withdrawing funds if you ever really needed to do that, too.

Sean: But there are contribution limits, which might put a damper on someone's aggressive retirement saving plans, right?

Chris: True, for 2021 IRA contribution limit is going to be $6,000 for the year. And which is pretty substantially less than a 401(k).

Liz: So we've been talking about IRAs, but Chris, there are actually two kinds of IRAs, right?

Chris: Yeah, that's right. So you have your traditional IRA and your Roth IRA. And the biggest difference is that with a traditional IRA, the contributions are typically tax-deductible, but the withdrawals are taxed later on. With a Roth IRA, you won't have those upfront tax deductions, but the withdrawals are tax-free in retirement.

Liz: And you can turn a traditional IRA into a Roth IRA with the process known as conversion. So can you talk about how that works and when you might want to consider a conversion?

Chris: Actually it's pretty straightforward. But again, the big thing to consider is the taxes that might come along with this conversion. You can only contribute post-tax dollars into a Roth IRA, which means any of the contributions you made into your traditional IRA, those are going to be taxed when you perform the conversion. And that goes for the gains that were generated in the traditional IRA too.

When you're thinking about these taxes, there's a few things you can do and some strategies you might be able to use that could keep the taxes down, that you'll have to pay. If you're ever in a lower tax bracket, for any reason, that could be an opportunity to do the conversion. Also, if you notice that your traditional IRA balance is lower during a market slump or anything like that, that could also be an opportunity to possibly pay less in taxes.

Also, you could consider doing the conversion earlier in the year. You have until April the following year to pay your taxes in full. And that could give you more time to space that out. You don't have to do the conversion in full. You could convert a little by little from your traditional to your Roth, that would help you spread out the taxes you'll pay over time.

Liz: We've been talking about the differences between the accounts. We've been talking about how to do it, but when should you consider converting an IRA to a Roth and paying all those taxes?

Chris: If you think that you might be in a higher tax bracket in retirement, that could be a reason to consider a conversion just because you're going to be taxed now on those contributions, as opposed to later. Also, if you have the cash to pay the tax bill, that makes a difference too, because that means you won't have to dip into your retirement account to pay for those taxes on that conversion.

Liz: Some people just like the idea of having a tax-free pot of money in retirement, because they are going to be paying taxes on the 401(k) withdrawals and a lot of financial planners like to have what they call tax diversification. So that's a pot of money that you can spend without having to worry about taxes. But anyway, it is a complicated decision. So don't rush into it, make sure you understand it before you do it.

Sean: Right. And maybe talk with your own financial advisor before making that decision.

Liz: Always a good idea, and a tax broker.

Sean: Yes. So what is the mechanical process like of converting an IRA?

Chris: Once you get the taxes figured out and you're ready to convert, it's pretty straightforward. You would open a Roth account just as you opened your traditional IRA. And then you can either get a rollover distribution in which often you'll get a check and you would use that to fund the Roth IRA. You can also have a direct rollover arranged, which would mean the two financial institutions that you're working with, they would organize the rollover directly between themselves. If you're using the same brokerage account, you could have them organize the transfer between the Roth and traditional account pretty easily.

Sean: So this has all been a lot about different ways to think about managing retirement accounts. But another thing that Shannon was wondering was whether and how to save for a down payment on a house. They're living in Southern California and obviously the houses there are pretty expensive. So I want to talk about this process a little bit more in depth.

So before we got on here, I was doing some digging and I found that in September, the median home price in Southern California was slightly above $600,000. This was quite a lot. And I don't even want to think about what that mortgage payment would look like. But I did a little bit of math thinking about how much Shannon might have to have saved up.

So let's say that Shannon saves up for a 3% down payment. That would be $18,000, but factoring in that they would probably need between 2% and 5% of the home's value for closing costs and factoring in a budget cushion there, Shannon should probably have around 10% of the house's value. So thinking about that median home price, again, Shannon needs around $60,000 saved to buy a house, which is intimidating.

So I'm wondering how we can think about how to save for that down payment over time. And Liz, since you actually have purchased a home in Southern California, I'm wondering what your thoughts are.

Liz: Well, I think the math that you did is a really good start. There are calculators, and we have them, to help you figure out what the costs are likely to be. So you might want to use those and just get an idea of a number, what you're shooting for, and then figure out how long you want to take to put this money aside. Obviously people are getting antsy because it feels like house prices just keep going up and up and up. But you also don't want to rush into a house and then be cash poor and not have money for things like paying the taxes and fixing the furnace when it breaks, because it will break ...

Sean: Or saving for retirement.

Liz: Or saving for retirement — you’ve got to do these things all at once. You can't do one and then the next. The math doesn't work out very well with that. So I would say set yourself a goal, figure out how long it will take to get there. If you do need to cut back a little bit on the retirement savings, it can make sense if you've already got a good start. If you are coming from behind, maybe that needs to be the priority, but a lot of times you can make the math work out by trimming a little bit here and adding a little bit there.

Sean: And in general, someone who has a longer time horizon before retirement can have a little bit more cushion to cut back on what they're saving for retirement. So they can reallocate those funds for something that might be a little bit higher priority, like saving for a down payment on a house.

Liz: Keeping in mind that there's no better time to save for retirement than when you're young, because you have all that time ahead of you for that money to grow. And the longer you put off saving, the harder it will be to catch up. But what we're talking about here is somebody who obviously has a good start and now is ready to take on another goal.

Sean: All right, Chris. Well, thank you so much for talking with us. This was a lot of fun.

Chris: Absolutely. Thanks for having me.

Sean: All right. And with that, let's get into our takeaway tips and Liz, do you want to kick us off?

Liz: First balance your priorities. Saving for retirement is important, but so is achieving other life goals like buying a house.

Sean: Next up, know how to optimize your retirement savings. Get the full 401(k) match if your company offers one, then look into contributing to an IRA.

Liz: Finally work backwards. Know how much you'll need for a down payment and closing costs, and how much you can save monthly to get there. Adjust as necessary to find the right balance between saving for retirement, a down payment and current expenses.

Sean: And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. You can also email us at [email protected]. Also visit nerdwallet.com/podcasts for more info on this episode and remember to subscribe, rate and review us wherever you're getting this podcast.

Liz: And here's our brief disclaimer, thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general educational and entertainment purposes, and may not apply to your specific circumstances.

Sean: And with that said, until next time, turn to the Nerds.