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Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

Where to open an emergency-fund account

Dear Dollar Diva,
We are 66 and 64. I have a 401(k) plan at work, Social Security and retirement benefits, and I'm still working. We have accumulated $130,000 in a money market account at the bank. We'd like to invest it in something with a better rate, but it needs to be safe and pretty liquid. What do you think?
Thompson

Dear Thompson,
Welcome to payback time! After many decades of working hard and living below your means, you've finally accumulated more cash than you know what to do with.

You're right: $130,000 is too much to be sitting in a low-interest money market account. The Diva is happy to suggest alternatives that will give you a better return and still provide the safety and liquidity you need.

Presumably, the cash in your money market account is to fund emergencies and big-ticket items, such as cars and expensive trips. It should also be enough to provide a cushion so you won't have to tap your equity funds in the future, when the market takes its periodic dips and you're no longer bringing in a paycheck. To make sure yours is offering the best rate, use Bankrate's money market account search engine. But rest assured: You can do better.

FDIC insurance limit
An observation: The FDIC's insurance limit is $100,000 per account. Your account has $130,000 in it; should your bank fail, you risk losing $30, 000. The risk is low, but it's not worth taking. To learn how to keep more than $100,000 in bank money market accounts and have it all FDIC insured, read Greg McBride's "Jumbos just aren't worth the risk right now."

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Where to stash your cash
In spite of the low interest rates, a money market account or money market mutual fund makes sense for cash you need instant access to. However, for cash you're not going to need for six months or more, here are some alternatives to consider:

  • Certificates of deposit: At this writing, 2.3 percent is the average interest rate on a six-month CD; 4.6 percent on a five-year CD. Interest is taxable in the year it's earned. Go to Bankrate.com's savings page for up-to-the minute rates.

Laddering is the investment strategy of choice for a certificate of deposit portfolio. A portion of your cash is invested in shorter-term CDs and a portion in longer-term CDs, giving you access to some of your money short-term, without subjecting the entire portfolio to the lower, short-term rates.

  • U.S. Series I bonds: I bonds are paying 4.4 percent through April 2002, and are indexed for inflation; the rate is adjusted in May and November. Go to the U.S. Treasury's Series I savings bonds Web page for the current rate.

You won't pay state or local income tax on the interest your bonds earn. For federal tax purposes, interest compounds tax-deferred until the bonds are redeemed. But you will forfeit three month's interest if you cash a bond before it's fifth birthday.

Each of you can buy up to $30,000 worth of I bonds per year. The Diva's "5 common questions about savings bonds" will tell you how to buy them and how to redeem them.

  • Pay down debt: Yields on savings accounts are so low, it makes sense to use some of your spare cash to pay off debt, if you have any: That includes car and mortgage loans.

  • Fund Roth IRAs: If you like tax-free earnings, fund Roth IRAs for your spouse and yourself. You can withdraw your original contributions anytime, but you'll get slapped with a penalty if you tap the earnings before five years are up. The Roth IRA can provide a tax shelter for interest, dividends and capital appreciation; why not use it?You have until April 15, 2002, to make 2001 contributions of $2,000 each. For 2002, the contribution jumps to $3,500 for folks over 50. You can make your 2002 contributions anytime between Jan. 1, 2002, and April 15, 2003.

    Unlike a traditional IRA, you don't have to take distributions from your Roth IRA when you're 70 1/2 years old; it can grow tax-free over your lifetime. You heirs won't have to pay income tax on the earnings, either. The ability to fund a Roth IRA phases out for joint filers with adjusted gross income between $150,000 and $160,000. See IRS Publication 590, Individual Retirement Arrangements for more details.

Read the Diva's recent Money Makeover, "Debtless and happy" for more ideas on stashing your cash and investing when you're lucky enough to have more money than you know what to do with.

Editor's note: In April 2006, FDIC deposit insurance coverage on retirement accounts held at banking institutions was raised from $100,000 to $250,000. Non-retirement account FDIC deposit insurance coverage remains at $100,000.

-- Posted: Jan. 24, 2002

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See Also
IRAs are a girl's best friend
Contributing to an IRA and a 401(k)
5 common questions about savings bonds

More Dollar Diva stories

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