May 16

If you read enough different Personal Finance blogs, you find that there are a number of popular recurring themes. Ways to save on various purchases, how to plan for retirement, etc. The one that’s been haunting me lately is, as the title today says, saving vs paying off debt. There are some obvious choices to be made, such as paying down an 18% credit card or putting that money in the bank to earn .01% interest. (Uh, if it wasn’t obvious, pay the damned card!)

But, then there’s the grey area where the debate really has no conclusion, no right or wrong, just what’s right for you. First, a disclaimer. In the PF blogging community, it’s ok to disagree. Disagreeing isn’t a personal attack in this case, it’s just a different take on an issue. That said, It was two months ago that I read Are 401(k) and 529 Plans a Good Idea When You’re In Debt? I was part of the 78 comments that quickly went up after Joan Otto (Man Vs. Debt community manager) wrote this article in which she described how she’d prefer to go at her debt 100%, even to the point of sharing that she was sorry she or hubby even had their 401(k)s to begin with. She explained that they had a combined $44,000 in their retirement accounts averaging 8% return, but $59,000 in debt costing 14%. Ouch. I understand that’s an issue. The real issue that Joan shared was that their 401(k)s had no match. Game over. Really. Joan’s plan to pay off her debt with a vengeance was exactly the right thing to do.


What drew me in to the discussion was where Joan remarked that even if there were a match, she’d pass on it, and take The David‘s advice. If your employer is going to match the first few percent of your income dollar for dollar, my opinion is to take this free money. The match is usually up to the first 4-6% of income, which should leave enough funds so the debt repayment plan doesn’t suffer too much. Joan mentioned paying $2500 per month (wow!) toward the principal on her debt. That’s $30,000 per year. I don’t know their income, but even if we are looking at $100,000, I’d suggest steering the $6000 toward the match if there were one to be had. But that’s all hypothetical.  Let’s move on to a real situation.

My ‘friend’ (ok, it’s a close relative. Let’s stick with friend for this delightful anecdote) mentioned that she’d qualify for a refinance of her mortgage once her credit cards were paid off. $10,000 at 18%, so the $400/month she was paying toward the cards would take nearly 32 months to pay off. She told me that she stopped depositing to her 401(k) and I thought about Joan’s story. My friend’s company  had a match, 4%. This was $3000 left on the table. I looked at the numbers, and made an offer. I wrote her a check to pay off the cards, and she’d putting in $250/mo to the 401(k). Since it comes off the top, it’s $188 less in her take home pay. This leaves $212 to pay toward the $10,000. At the end of 32 months, she’ll still owe me $3,680, but her 401(k) will have $16,000 that wasn’t there before. Yes, the $16,000 is pretax, but she’s over 55, so if she changed jobs she can take it out with no penalty, just tax. At 25%, she’d still clear $12,000. I’m not forecasting any gain, in fact, she’s probably wise to keep this money in the short term bond fund for now, to know that it’s safe. And the refinance – once the cards show as paid on her credit report, the refi should save her another $200 per month.

There’s something admirable about killing the debt, I get that. I get that debt feels like a weight you just want to get rid of. But after nearly 30 years of matched 401(k) deposits, I see the power of compound growth on top of matching deposits. I see that I could have taken $200K over the years and paid off my mortgage by now, or I can have that $200K in debt and far more than twice that sitting in a retirement account. It’s tough to stay the course, especially when you look at how the S&P has crashed twice in the last 15 years. For most 401(k) accounts, I’d say to deposit to the match and that’s it, but walking away from that free money is a mistake, in my opinion. Keep in mind, most 401(k)s offer a low risk investment choice. Even though I might not choose it myself, it’s a good alternative to using the excuse of a ‘risky market’ to avoid saving altogether.

How have you handled the debt decision? Are you passing up a match in your retirement account?

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May 01

Last February, I asked the question – Are you 401(k)o’ed? I was concerned that my readers might not have been aware of the fees they were paying inside their 401(k) retirement accounts. It seems that this topic has hit the mainstream media, and recently, PBS’ Frontline ran their story The Retirement Gamble which you can see on line if you missed it.

The message is simple, over time, fees will destroy your returns. Over a lifetime of investing the difference between a .1% cost and a 2% cost is insane.


Jack Bogle, the father of index investing, is interviewed and discussed these numbers, how the market might grow your $10,000 to over $45,000 over 50 years at 8%, but a 2% per year cost will confiscate nearly 2/3 of your returns. Unfortunately, Jack misspoke when he said, “Get Wall Street out of the equation. Get trading out of the equation. Get management fees out of the equation. You own American business and you hold it forever. That’s what indexing is. Own a fund that owns the entire U.S. stock market, does no trading, and has a cost of 1 percent a year to own. And that is the only way to do it. Then you’re with a creature of the market and not of the casino.” Even 1% isn’t great, you’d still lose 1/3 of your money over the five decades in his example. A tenth of a percent is more like it. Over the years, there’s still a $20,000 loss to fees, but we’re talking 50 years in the example. The quote got it right, but I think Jack meant to say a tenth percent.

It was decades ago that Jack Bogle promoted the concept of indexing and founded Vanguard’s Indexed Mutual Funds long before ETFs were invented. Anyone who has any background in finance and investing would be aware of Bogle, Vanguard, and Bogle’s thesis that managed funds can’t add enough value to exceed their high costs.

Everyone except for Christine Marcks, President, Prudential Retirement who responded with, “Yeah, I haven’t seen any research that substantiates that. I mean, it— I don’t know whether it’s true or not. I honestly have not seen any research that substantiates that.” The interviewer asked if she’d seen the research Vanguard had done on the topic and she replied, “No, I haven’t. I haven’t— I haven’t read everything. But so much of it depends on, you know, what I need is different than what you need and there’s not an asset allocation or a fund strategy that’s right for everybody.”

One last quote from Jason Zweig of the Wall Street Journal, “And one of the ultimate dirty secrets of the fund industry is that a lot of people who run other fund companies own index funds in their— in their own accounts and don’t talk about it, I mean, unless you put a couple beers in them.” I suspected that, myself.

To be fair, not all 401(k) funds have such high expenses, the S&P fund in my own 401(k) is .06%, less than a 3% hit over 50 years. Frontline also missed, or ignored, any discussion of matched funds. My own advice is when your company offers a dollar for dollar match, you should grab it. The decades pass quickly and you’ll look back at a high six figure account and see how nearly half the money came from your employer instead of from your wallet.

Check out the show and let me know, did you feel it was balanced? Was I too tough on Christine Marcks? Have you check the fees inside your own 401(k)?

written by Joe \\ tags: , , ,

Apr 09

The news is out that President Obama is looking to introduce legislation to limit the value of retirement accounts to $3 million. So far, the claim is this targets IRAs, but it’s a simple matter for many of the big account holders to simply transfer from IRA to 401(k), so it would seem logical that once we see the full details, this limit will apply to all retirement accounts.

The news articles are suggesting this limit was a response to the fact that Mitt Romney amassed an incredible $100 million in his IRA. I spent a bit of time before the election writing about Romney and specifically in an article titled Romney’s Enormous IRA Balance – The Smoking Gun I spelled out the issues of how it’s unlikely the account grew to this value naturally.

I’m all in favor of Romney’s IRA getting taken apart, i.e. taxed. A current limit of $3 million will not affect the average Joe, take a look at these numbers. You can click the image to enlarge it).


The data is a bit old, but 2007 ended with the S&P just a bit lower than it is now, so for this discussion the chart is fine. We’re looking at median family net worth. For those in the top 10%, half have below $1.9 million, half higher.  5% of families have a net worth over $1.9 million. It’s not too great a stretch to assume that to specify $3M in one’s IRA or 401(k) is some smaller fraction, likely the 1%ers or even a bit fewer. So why all the fuss?

Very simple, remember the AMT. Specifically, I mean you should remember the origin of the AMT. It was created as part of the Tax Reform Act of 1969 intending to target the 155 high income households that managed to pay zero Federal Tax. By 2008, 4% of filers were subject to AMT with 27% of these households having incomes under $200K. Today, $3M still seems like a large number, but inflation has a way of eating away at the dollar. An inflation calculator showed that in my lifetime (50 years) the dollar has eroded by a factor of 7.5X. In other words, something costing $100 in 1962 would cost $750 today. That $3 million IRA cap will feel like $400,000 50 years from now. I know, we can’t forecast a few years out, 5 decades seems crazy. For me, it’s a ‘horse out of the barn’ event. $3M now, but easily adjusted down at congress’ whim.

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Mar 11

I recently read a question from a fellow blogger Briana, who posts at How’s Married Life asking how much she should save to her retirement account each year. As I saw comments come in, for me the larger question wasn’t how much, but simply ‘how.’ Should she save pretax, or post? In the big picture, this question might take second place to the first, after all, the question of how much is such a large factor toward retirement success.

Let’s look at my concern, how she should handle the tax status issue. In her question, she shared her gross salary is $33K.  In 2013, the 15% bracket runs from a taxable $8,925 to $36,250. With no mortgage (yet), I’ll trust she’s taking the standard deduction  of $6100 along with an exemption of $3900. Pretty neat, this adds to exactly $10000 that comes off the top. At this stage of her life, I’m expecting good things in her future, and that includes a higher income.

I suggest that she start now with the Roth 401(k) and Roth IRA for the money she’d like to save. The Roth 401(k) to get the full match her company offers, and the Roth IRA for any more deposits above that. It will take some time before she’s starting to hit the 25% bracket. After all, she would need an income above $46,250 for that to occur when the standard deduction and exemption are included.

As time passes, and she sees her income rise, I suggest monitoring that line on her 1040, “taxable income,” this is the line that tells you what bracket you’re in, and as she slips into the 25% bracket, it’s time to take advantage of the pre-tax retirement accounts as well. Say, she’s finishing her return one March and sees the taxable income is $1000 into the 25% bracket. That’s the time to deposit exactly $1000 into the pre-tax IRA, and start using the pre-tax traditional 401(k) as well just for a portion of her deposits. Say she’s decided to target 10% of her income towards the retirement accounts. It will take $51,389 gross income and a pretax deposit of $5,139 to net that $46,250 I mention was the gross cutoff for the 25% bracket. Keep in mind, that’s in today’s dollars, with today’s tax brackets and current standard deduction/exemptions. These numbers are all inflation adjusted each year and this combination will help shift that target 15% limit as Briana’s income rises. It may take as long as a decade or more for this to occur, which is fine. Ten years of saving post tax money in these accounts before making the shift to pretax savings means her tax burden after retirement will be that much lighter.

The story doesn’t end here. If, and when, she has a new addition to the family, there are more tax deductions that come with the new bundle of joy. Briana may have spent a bit of time fighting off a 25% tax rate only to take a bit of time for maternity leave and drop back to 15% again that year. The good news is that with a bit of planning each year for the year to come you may find the 15% solution works to keep your taxes low while your working and then at retirement when you find your funds have a decent share as post tax Roth flavored money.

On a final note, recent changes in the tax code permit a conversion of 401(k) funds from the pre-tax account to the Roth 401(k). Since matched deposits always are deposited to the pretax traditional side, you’ll still accumulate pretax money over time. If you have extra money you’d invest for the long term and the 401(k) fees are reasonable, it may make sense to do the conversion if you will still be in the 15% bracket. There’s no recharacterization option, so plan wisely.

Briana, I wish you health, happiness,  and wealth. Best of these to you!

written by Joe \\ tags: , ,

Oct 18

fidelity chart

Many articles have been written about the savings you need to have at different ages. In 2009, I wrote my own article Retirement Savings Ratio, which included a spreadsheet to track your own situation. Fidelity recently offered a chart which the New York Times picked up and ran as a story. What’s amazing to me is the numbers are not correct. To be clear, I’m accepting the assumptions Fidelity offers. 5.5% is a pretty conservative growth number, as is a 1.5% annual raise.

Now, when you take the spreadsheet and do a bit of editing, the numbers speak for themselves.

  • Zero out savings from 20 through 24.
  • Change Annual Raise to 1.015 (this is 1.5%)
  • Change percent saved to .15, then manually change the percent to 9 for age 25 and increase 1% each year till age 30
  • The above builds in the 3% employer deposit, so all set there.
  • Annual return is 1.055 (this is 5.5%)

Sorry if this is a bit tedious, but it’s how you can see the numbers for yourself. The result is that the chart underestimates savings by nearly 50% by retirement at 67. From the spreadsheet I wrote:

Age X Salary
25 0x
30 .09x
35 .75x
40  2.91x
45  4.34x
50  6.07x
55  8.18x
60  10.73x
67  15.25x

I was tipped off that something was wrong when I saw linear growth, 1x through 6x every five years. That alone told me these numbers weren’t calculated correctly. Growth over time is exponential, not linear. Don’t believe me, pull a copy of the spreadsheet and run the numbers yourself. Most important, don’t believe everything you read. Unfortunately, I can’t get a copy of the underlying spreadsheet Fidelity used to produce their chart, but you can grab a copy of mine.

Keep in mind, rules of thumb are just that, guidelines that apply to people in the center of a range. Some people retire and find that with 40-50 hours more time each week, are spending far more than they did prior to retiring. Others were saving 20% for retirement, 20% went to the mortgage, and 20% or more to college tuition payments. These folk were living on less than half their income. This article was not about calculating your number but about my observation how one pro got it wrong. A future article will discuss your number in greater depth.

written by Joe \\ tags: , ,