When you look around at people’s lives there seems to be 2 things that show up in most people’s financial worlds.  If they aren’t there directly it’s 2 things that the people are working towards.  Any guesses?  They are both marketed to widely by the largest financial companies in the US.  Give up?  The 2 things are your 401k and your house.

Chances are you read everywhere how you should be contributing as much as possible to your 401k.  Most of these messages are initiated by two groups, the financial companies and the government.  Then you add in that your whole life you are told that you need to own your own house.  It is instilled in us at such a young age that most people never even question it.  They work to get a mortgage, in order to get their own house.  I have to ask, is this a good thing?

As I was reading The Best Way to Avoid the Worst Financial Problems from @wisebread it reminded me of the 6 principles of the Evolution of Wealth.  Honestly, I have put aside the principles that I originally wrote up.  Why?  Well I really don’t have a reason, basically because life happens and I’ve tried to let this blog go where it goes.  It was the following paragraph in that post that jumped out at me:

I can give it to you in once sentence: Keep the cost structure of your household flexible. That is, arrange your life so that you can react to a fall in your income by reducing your expenses.

This screamed principle #1: the power of LUC.  Did I forget the k?  No.  LUC stands for liquidity, use and control.  These are the main features of flexibility.  Now let’s look at the 2 most popular financial tools that play a major role in everyone’s financial world.

How does a 401k provide flexibility?  Does it provide liquidity, use and control?

1. Liquidity – Fail!  When flexibility is most important, it is difficult to access the money that you put into a 401k.  There are penalties and fees associated with the access as well as probably having to jump through a few hoops.
2. Use – There’s only 1.  It’s saving for retirement.  The money is in your account doing 1 thing, or should I say hopefully doing 1 thing.  People loose track of the main purpose or maybe the only purpose of a 401k.  Saving for retirement.
3. Control – Do you even have any?  The government dictates when and how you can access the money.  The employer or plan administrator dictates the rules surrounding access and investments.  Might you just be a pawn?

How about your house?  Any flexibility there?

1. Liquidity - Is it easy to get money out of your house?  I guess you might be able to convince me if and only if you have a large equity line of credit established.  Oh, what did you say?  Banks are taking those away?  Guess this is a FAIL too.
2. Use - You could make an argument for some use here.  It provides shelter.  It provides some tax benefits.  It might provide some rate or return (emphasis on maybe).
3. Control - This should be a good one…who controls your house?  Let’s see, you need to ask permission and prove that you should be able to pay just to get a mortgage.  Then if something bad happens, just when you need there help the most, the bank says ‘NO’.  Doesn’t sound like much control to me.

Might the 2 most widely used financial tools also be the worst based on Principle #1 and wisebread.com‘s “Avoiding the Worst Financial Problems”?

Related posts:

1. Max Out Your 401k Math
2. 401k, God or Devil?
3. 6 Reasons Not to Max Your 401k

Have you heard of the new IRS website for small businesses? In an attempt to make it easier for small businesses to find the right retirement plan, the IRS has rolled out the IRS Retirement Plan Navigator.  It is tagged as “An easy retirement plan guide for small employers”.  It’s main content is directed to choosing, maintaining and correcting a plan.  As well as providing a plan comparison table.

Do you think a website like this really works? It does accomplish providing a comparison based on very broad information.   Does that really help an employer?  Or does it just confuse them?  I guess I just feel bad for the small businesses out there, trying to do all of this themselves.  It must take a lot of time and effort.  Isn’t it just easier to have a trusted professional do it for you?

What other options does an employer have? They can do the research themselves or they can find someone to do it for them.  At the very lease they will need an investment company/person to work with no matter what their plan.  Isn’t it easier to just start their and find a trusted investment person to help you figure out which plan is best?  Do they feel it is easier to deal with the person that answers the 800 number after they’ve done all the research themselves?  The time it must take to figure out what type of plan they want and who they want it with.  How many man hours do they put into this research?

What can you do to help? Most employees feel helpless about their retirement plan options.  Have you talked to your employer about it?  Better question, do you know who to talk to?  Take 5 minutes out of your day and let the HR department or CFO or owner of your company know what you think of their retirement plan.  If you love it, tell them.  If you hate it, tell them.  Just make sure to tell them why you feel the way you do so that they know what kind of job they are doing and how to make it better.  This information will be a lot of help to a good employer, trust me.  Send me an e-mail and let me know how you feel about your employer plan.  I’m interested and maybe I can help if you need it.

Related posts:

1. Who Controls Your Retirement Money?
2. Max Out Your 401k Math
3. 2 Worst Financial Tools

You can read anywhere and everywhere about how so and so lost x amount of money in their 401k or retirement accounts.  How much did you lose?  Is it done 10s of thousands?  100s of thousands of dollars?  I wonder, if someone came to you and said I can give you a safety net on your investment but it will cost you a percentage of your return, what percentage would you pay for that, if any?  Would you give up 1% per year to guarantee a safety net of 6%?  What if that safety net only cost you 0.5% per year?

No one can predict the future of the market.  They will always try and someone will guess right but no one knows for sure.  I find that as people get closer and closer to retirement they become more and more cautious of their investment losses.  Makes sense right?  Would they sleep better knowing that they had a safety net?

You might say why not just invest in safe investments.  My response to that is opportunity cost.  How much do you give up over the long term by moving to safe investments.  In todays environment you’re lucky to get a 2% rate of return from your 1-year CD.  According to the AllFinancialMatters the 20-year return for the S&P 500 from 1989-2008 is 8.41%  That gives an opportunity cost between the two of about 6%.  This gap is as big now as it has ever been due to interest rates being at historic lows.

What if you can have your cake and eat it to?  Let’s say your 55 or so years old.  You are very likely to live another 20 years if not 30 or more.  You plan on retiring in about 10 years and you’re a bit nervous about being invested in the market yet you need some returns on your money to retire comfortably.  You might even have a financial planner that showed you a nice compound interest curve.  Maybe you even realized that as your asset allocation gets more conservative you just might be Destroying Your Compound Interest.  What if someone offered a safety net?  Now it’s not free.  You get a guarantee that your account won’t earn less than 6%.  Meanwhile the account still stays fully (or as much as you choose) in the market.  The cost is that your fee comes out of your return.  So that if you earn 9% you would only see an 8 or 8.5% rate of return depending on your fee for this safety net.

There’s a lot more details to this obviously but I’m just wondering what fee would you be willing to pay.  Would you pay 1%?  Would you pay less?  I also understand that your answer might be different today than it would have been in 1999 or even in 2007.  That’s why I’m asking you today.  If you want clarification or you have questions, e-mail me.

No related posts.

If your goal is to put as much money as possible into your 401k then you best bet is to fully fund your Roth 401k. The IRS set the contribution limit for your 401k in 2009 to $16,500 and a $5,500 catch-up contribution if you are over age 50. The funny thing is that the IRS doesn’t differentiate between Traditional and Roth contributions. They are not equal.

With a Traditional 401k contributions are pre-tax which means that you don’t pay taxes today. So if you were to max out your Traditional 401k then you could contribute $16,500 or $22,000 if you are over age 50. Simple enough right?

Now is the fun part. If you were to contribute to a Roth 401k the limits are the same. Remember though, that this is post-tax contributions which means you pay taxes today before the money goes in.  So if you were to contribute the maximum of $16,500 you would really be putting aside even more income depending on your tax bracket. Let’s say you are in a 25% federal tax bracket. That would mean you would essentially be putting aside $22,000 of your income for retirement. If you were over age 55 that number would be about $29,333. My point is that it’s not apples to apples so make sure you are realizing how much you are contributing.

To take this one step further. You max out your 401k. Either way $16,500 goes into the account correct? It grows at about 7% for 30 years. Using the Rule of 72 we know that it will double every 10 years. So it doubles once to $33,000, twice to $66,000 and a third time to $132,000. Are you with me so far? Good. Here’s the key. If you have $132,000 in a Traditional 401k you still owe taxes on it, at 25% worst case scenario you really only have $99,000. Where as if you have $132,000 in a Roth 401k you really have $132,000.

If you goal is to put away as much money as possible for retirement then you should be taking advantage of the Roth 401k. If it’s not an option for you go to your HR or the owner of your company and ask them to make it an option. In most cases it can be added at no cost. If there are any questions please direct them to me.

One more side not, whether you contribute to the Traditional or Roth portion of your 401k, any employer match will be pre-tax so it will show up in the Traditional portion.

Related posts:

1. 6 Reasons Not to Max Your 401k
2. Tax Savings, The Finale
3. 401k, God or Devil?

Have you been following along?  In our attempt to dispel myths surrounding retirement savings and how it affects your taxes, I think we’ve learned a lot.  Have you learned some new things?  What has been your favorite so far?

Let’s look more closely.  We have learned how the Traditional 401k and Roth 401k work.  We have also taken a look at what it says in your enrollment booklet.  A lot of those booklets mention tax savings that we have been looking for all along.  We just can’t seem to find it yet. 

In episode I: Tax Savings, Where’s That?, we saw that even if we save the money we don’t have to pay in taxes it probably won’t be enough to offset the taxes we will have to pay later.

Then in episode II: Tax Savings, It’s In The Paycheck?, we saw that saving money pre-tax versus after-tax doesn’t mean you have more spendable income.

In the last reading, episode III: Tax Savings, Advantage Over The Roth?, we saw that, all things being equal, the Traditional 401k equals the Roth 401k in the long run.

With all these things what questions are left?  One question you might have is that in episode I we demonstrated what happens if you save the supposed tax savings.  Well where is that accounted for in episode III?  You might even argue that your better off with the scenario in episode I because you’d have the extra $17,000.  The problem is that all things aren’t equal between the two.  See in episode II we established equal spendable incomes.  Between I and III we have two different spendable incomes so these aren’t apples to apples.

What we are left with is that everything being equal, apples to apples, all things are the same.  So it’s the almighty question, if you change the variables how does it affect the scenarios?  Let’s look at it.

Taxes are probably the easiest one.  If you think that taxes will go up in the future then it is more beneficial to contribute to a Roth.  It’s taxed at today’s rates.  Does anyone believe that taxes will be more favorable in the future?

The other main thing to look at is distribution regulations.  The Roth has the definite advantage here.  The biggest thing is not having to take withdrawals after the age of 70½.  This allows your money to continue to benefit from tax-deferred growth.  There can also be more flexibility with early access of a Roth account, definitely an IRA and depending on plan documents, a Roth 401k, as you may have access to the contributions at anytime.

Now that we’ve looked at some fallacies surrounding your Traditional 401k, has it changed your opinions at all?  Is it going to change your behavior?  You need to ask yourself where do you want to be in retirement.  Is your goal to live off less money?  Chances are you will have a lot less tax deductions, if any.  There seems to be a trend of taking those away from taxpayers, don’t you think?  Maybe you’ll have less expenses, pay off the mortgage?  Or maybe you’ll have higher expenses trying to keep up with health care or your hobbies?  I mean you need something to pass the time that you previously spent working and if it’s not making money then it just might be spending it, right?

Related posts:

1. Tax Savings, Advantage Over The Roth?
2. Tax Savings, It's In The Paycheck?
3. Tax Savings, Where's That?

We couldn’t find a tax savings in pre-tax contributions in Episode I: Tax Savings, What’s That?

We couldn’t find the tax savings in our income in Episode II: Tax Savings, It’s In the Paycheck?

I think we might have found it in the classic debate of Traditional 401k versus Roth 401k.  You’ll remember in Episode I that our $10,000 grows to $80,000 at 7% over 30 years.  When taxes come into play at our 25% tax bracket the $80,000 quickly becomes $60,000.

Roth 401k

The key difference of the Roth 401k is that money goes in after-tax so that growth is tax-deferred and the withdrawals are tax-free.  We start with our $10,000 then pay our taxes before we can contribute to the Roth 401k.  This puts $7,500 into our retirement account.  Using the Rule of 72, again, we know that it will double every 10 years.  It doubles once to $15,000, twice to $30,000 and third times a charm, to $60,000.

$60,000, either way we look at it we end up with the same amount.  Where’s the tax savings there?  Oh your remember that we a good boys and there’s some extra money not accounted for from Episode I.  I guess you’ll have to wait for the season finale to get that explained.

To Be Continued…

Related posts:

1. Tax Savings, The Finale
2. Tax Savings, Where's That?
3. Tax Savings, It's In The Paycheck?

This is a continuation from: Tax Savings, Where’s That?

Well we couldn’t find the tax savings in the first post.  However, you remember those enrollment books we mentioned in the last post.  They mention having more money in your paycheck.  So the tax savings must be there, right?  Let’s look at it…

We have our $4,000 paycheck here.  We’re going to have our $400 Traditional 401k contribution come out pre-tax.  Then we only have to pay taxes on $3,600.  Great.  In a 25% tax bracket that means we only pay $900 in taxes.  That leaves us with a spendable income of $2,700 (4000-400-900).  With the Roth 401k the taxes come out first.  So we get our $4,000 paycheck and first take out $1,000 for taxes.  Then our $300 Roth 401k contribution, that’s $400 minus 25% taxes.  This leaves us with a spendable income of $2,700 (4000-1000-300).  Wait, that’s the same amount.  That isn’t right is it?

We paid less taxes, $900 vs $1,000.  Plus we have $400 in our 401k instead of $300.  Yeah, we have the same spendable income but this must be the advantages we are looking for.  So the advantage is in the Traditional 401k? 

To Be Continued…

Related posts:

1. Tax Savings, The Finale
2. Tax Savings, Where's That?
3. Tax Savings, Advantage Over The Roth?

Have you ever read an enrollment book for your 401k?  A lot of them show examples of how much ‘tax savings’ you can get by investing in your 401k.  They say that if you are in a 25% tax bracket that for every $100 you contribute you’ll pay $25 dollars less in taxes, right?  Ever hear your account tell you that a strategy for paying less taxes is to max out IRA or 401k contributions?  Do you believe these statements?  Let’s look at it…

You’ve got an extra $10,000 you want to put away for retirement and you are trying to figure out whether to do all in your Traditional 401k or all in your Roth 401k and you are in a 25% tax bracket.  You hear about this great ‘tax savings’ so you say…

Traditional 401k

You have $10,000 the full $10,000 goes into your Traditional 401k.   So you’ve probably been told that you don’t pay taxes on the $10,000 so you’re saving $2,500 in taxes, right?  To keep that math simple we’re going to use a 7% rate of return and the Rule of 72 let’s us estimate that it will double every 10 years.  So in 10 years it doubles to $20,000; another 10 years and it’s $40,000; and the final 10 years and you have $80,000.  Now your in a Traditional 401k so the growth is tax-deferred which means you don’t owe any taxes on the growth.

Now when you want to access the money in your Traditional 401k it’s fully taxable because you haven’t paid any taxes on it right? Right.  So all things kept equal, you are still in the same 25% tax bracket because who wants to retire on less money.  That means you owe $20,000 in taxes on your $80,000.  So you only really have $60,000.

We forgot something, your ‘tax savings’.  You’ve been a good boy and saved the $2,500 you were told you saved.  So you put it into an investment and it got a 7% rate of return, so you’re doing awesome.  It doubles, $5,000; doubles again, $10,000; then the final double, $20,000.  Great so your laughing all the way to where ever you want as you go to cash in this investment.  You are about to offset the taxes they say you owe and guess what?  Your hit with capital gains (best case scenario) on your investment that you just sold off.   Now today that’s 15%.  So where do you come up with the money to pay the $3,000 capital gains tax bill?  You now have $17,000 to pay a $20,000 tax bill. 

Where’s your ‘tax savings’? 

To Be Continued…

Related posts:

1. Tax Savings, It's In The Paycheck?
2. Tax Savings, The Finale
3. Tax Savings, Advantage Over The Roth?

I think everyone, at sometime or another, has heard that they should max out your 401k.  Well I’m here to give you a few reasons to think about that.  At the very least, think of who profits from that message.  The investment companies profit, the administrators of the plans profit, and I’ll even argue that the government wanted you to do it.  I say wanted because I think times have changed and so they have adjusted.  With record governmental debt I think they now want your money sooner so they offered the Roth 401k.  I hate to tell you but I think the government puts their own interests ahead of yours.

Now I’m not telling you to not contribute to a 401k I’m just saying not to max it out.  I usually tell people to contribute up to the company match.  That’s it.  So here’s my reasons…

1. Government Rules

I don’t like anyone telling me what I can do with my money.  I don’t like them telling me at what age I can access it.  I don’t like them telling me that I have to take it at a certain point.  I’ve worked hard for my money, I want to dictate what I’m going to do with it.  I can get tax-deferred growth in other accounts.  At least in a Roth IRA I can access contributions.

2. Plan Documents

Have you ever read your 401k’s plan documents?  Did you know they can further limit the access of your money?  They can dictate how you access your money.  This paper work is long and full of legal jargon and essetially governs your money including access, fees, contributions, investments and more.  Yes, the government controls plan documents in some areas but they also give a lot of leeway in other areas.

3. Fees

Do you even know what your 401k fees are?  Chances are your company doesn’t either.  The government is working on trying to make these more transparent.  The bigger the company you work for the lower the fees, probably.  The tricky thing about 401k fees are that they can come right off the performance.  The fund earns 8% and your account is only credited 7% because you just paid 1% in fees.  That doesn’t show up as a line on your statement.  Also these fees can change at any time, see number 2.  Maybe in tough times the company doesn’t want to pay a penny for the 401k so they pass all the costs onto the participants(you).  Maybe you see a line on your statement that comes out of the account or maybe you never see it.  Are you getting the picture?

4. Tax Saving Fallacy

By contributing to a 401k you do not save taxes, you defer taxes.  That means that if all things are equal you will have the same amount of money in the end with a traditional 401k as with a Roth 401k.  Ever dollar you put into a 401k has an IOU associated with it.  When you access that dollar the IRS wants a percentage of it as an IOU.  As your dollar grows, so doesn’t their IOU.  So then what are the tax variables: tax rates & tax brackets.  Who controls this?  The government.  Where do you think taxes will go in the future?  Up or down?

5. Tax Management

This brings me to my next point.  Take control of your taxes.  You can manage your taxes.  Manage them today, tomorrow, in the future and especially, in retirement.  If all your money goes into your traditional 401k then it is all taxable in retirement.  That means everything you withdraw is reported as taxable income.  My guess is you will be out of deductions.  No dependents, no work expenses, smaller mortgage if at all.  That could easily mean more taxes on a smaller amount of taxable income.  Then your social security, if it’s still around, can be taxed as well.

6. Diversification

Is this a dreaded word now?  I’m hearing people say diversification is dead.  I think that’s funny because bonds have outperformed stock right?  So if you were diversified between the two you shouldn’t have lost 60% right?  The problem in 401ks is that you get very limited options within an asset class.  Yes, your plan might have every asset class covered but who knows how good the funds within an asset class can be.  401k companies tend to favor certain fund families especially if it’s a mutual fund company that handles the investments.  Fidelity wants their funds in the plan and so doesn’t every other fund company.  Yes, Fidelity has good funds but not in every asset class.

That’s my list, what do you think?  As a side note on diversification, maybe you want to diversify outside of traditional asset classes.  Most 401ks don’t give you the option to.  Let’s not forget the two biggest advantages of a 401k, the match and payroll deductions.  Take the match.  It’s great that the money comes out of your paycheck automatically without you ever getting to touch it.  So if you aren’t going to rely on just your 401k you will have to use some self restraint.  Is that plausible for you?

Don’t forget the first principle of the Evolution of Wealth: The power of LUC (Liquidity, Use and Control)!

Related posts:

1. Max Out Your 401k Math
2. 401k, God or Devil?
3. Tax Savings, Where's That?

Did you know that the investment companies might just be out to make money?  Yeah I said it, they really might not have your best interest in mind.  Imagine that?

On the Wall Street Journal’s website they have an article title “The 401(k) Rollover Conundrum“.

This is a great example of misinformation in the marketplace.  How do investment companies make money?  They do it by keeping your money as long as possible and charging you as much as possible.  If, as the article states, fees are sometimes lower in a 401(k) wouldn’t the investment companies stand to make more money by retaining your rollover?  Also their fear of you rolling it elsewhere is going to make them push you to keep it with them.

Imagine you go to Fidelity’s website and you are looking for advice.  You figure that depending on how you answer a serious of questions you’ll get different advice.  Wrong!  No matter how you answer questions they say the same thing, roll your 401k into an IRA with us.  Then other companies don’t even give you all the information.  The do an apples to oranges comparison with someone who doesn’t like oranges.  Can’t loose there can you?  Or at least the company can’t loose.

You would think the agencies that are out there to protect people from this type of practice would step in.  I mean where is FINRA when you need them?  I’m pretty sure they frown on blanket recommendations.  How do you feel about this?  How do you feel knowing that Fidelity, Charles Schwab, T.Rowe Price and you can bet there are a lot more, are out there telling you to give them your money regardless of your situation?  They will be the first people to help you roll that money right over to their company.  Isn’t that how they make their money?

Here’s Fidelity’s ‘rollover evaluator‘ let me know if you can get any answer out of it other than “Roll your 401k into a Rollover IRA”.  I tried but they keep giving me the same answer and then next step is always to contact them?

Related posts:

1. 401k, God or Devil?
2. 6 Reasons Not to Max Your 401k
3. 2 Worst Financial Tools