Mellody's Mail: Right Financial Track

QUESTION: My wife and I are both 36 years old and have no children. We have paid off all of our debt, except our house. We have just refinanced our house at an interest rate of 5 1/8 percent. My wife just started a new job so she cannot contribute to a 401(k) yet, but I have my 401(k) maxed out and I contribute 4 percent to my company stock purchase program. We have more than $50,000 in a savings account and we add about $700 a month to it. What should be our next investment step?

ANSWER:It sounds like you are on very solid financial footing. If you already have at least three months worth of living expenses saved in an emergency fund, the next step would be to invest in mutual funds and if you are eligible, you should definitely invest in a Roth IRA. Like a 401(k), a Roth IRA is a tax-advantaged way to save for retirement. In 2004, you can contribute up to $3,000 to a Roth IRA (the contribution limit will increase to $4,000 in 2005), and your contributions and earnings grow tax-free. Withdrawals after the age of 59 ½ are tax-free as well, which is a tremendous benefit. To participate in a Roth IRA, your adjusted gross income cannot exceed $95,000 for single tax filers and $150,000 for joint tax filers. Keep in mind, unlike a 401(k), with a Roth IRA, your contributions are made with after-tax dollars so they do not reduce your taxable income. If your AGI exceeds the Roth IRA limits, a traditional IRA is a good alternative option. With a traditional IRA, you can contribute up to $3,000 in 2004, and your contributions and earnings grow tax-deferred, meaning you only pay taxes upon withdrawal.

In addition to investing in an IRA, you should also consider opening a regular (i.e., taxable) mutual fund account. While investing in a mutual fund is riskier than putting your money in a savings account, the rewards can be much greater. As you may know, a mutual fund is a collection of stocks, bonds or other securities owned by a group of investors and managed by a professional investment company. Mutual funds have several benefits, including: