Jul 09

I was listening to my local news station when a segment came on, a 5 minute bit of money advice with a local author and financial planner, Jonathan Pond.

I like his conservative approach. What’s unfortunate is that a quick few minutes to discuss any financial topic is going to miss some important details. In this case, the host asked what one should do with their 401(k) when they leave a job. Jon’s answer was to not leave it languish in the old account, to move it to an IRA. I hope listeners took that advice as “don’t forget about the 401(k), get more information.” I often say that it’s called personal finance  for a reason. Not all situations are identical. Let’s review 3 situations where leaving the account where it is would be best:

  • You were 55 or older when you left the company. Did you know that if you retire at 55, and try to take an IRA withdrawal before age 59-1/2, you’ll pay a 10% penalty? Yes there are some workarounds, a Sec (72t) withdrawal for instance. The simplest thing, however is to leave the funds in your 401(k) where you can withdraw with a 20% tax withholding, but no penalty, if you separated at 55 or older.
  • Your old 401(k) had great investing options. It’s possible. My old company 401(k) uses a Vanguard S&P fund that has a .02% annual expense. This is a $200 fee for every $million invested. The typical 401(k) expense is 1% or .02% per week.
  • Last, you’ve been doing well, well enough that you can’t make a pre-tax IRA deposit. Still, each year, you can do the back door Roth. Deposit to the IRA and immediately convert to Roth. Easy, right? Yes, but if you transfer your 401(k) to an IRA, and then try this maneuver, you’ll be in for a headache and tax bill. Conversions to Roth are prorated, all your IRA money is considered. So if you had $95K in your IRA and then deposit $5K to convert, 95% of the conversion will be taxable. Keeping the funds inside the 401(k) is the way to keep these funds segregated.

Are you making this decision right now? What factors have been part of your thought process? Have friends or family been giving you advice to go one way or the other?

written by Joe \\ tags: ,

Apr 16

I’d always thought, and advised others, that to retire, one should have their mortgage paid in full. And that was always my own plan. But, anyone who knows finance knows that you can’t plan on an exact stock market return, you can’t plan on your own health being excellent, nor your marriage outlasting your mortgage. In our case, these things actually all are going pretty well, thank-you. What changed was our income which I posted about a few months back. While we were working, we saved, over 20% per year on average. We topped off the 401(k)s and IRAs, and put aside money for our daughter’s college tuition. In hindsight, we could have saved a bit less, and aggressively paid off the mortgage, and I know there are people who are in the Dave Ramsey “debt is evil” camp who will agree, but I have no regrets. I’m a numbers guy and as rates fell, I was a serial refinancer. We entered our retirement phase with a fresh 15 year 3.5% mortgage.

When we lost our jobs, the balance was $265K, and I did the math to see what it would have taken to have no loan on that day. Our average interest rate was 6.0% over the prior 15 years. An extra $935 per month for that time and we’d have no loan. Keep in mind, the market was interesting during that 15 year stretch from 1998-2012. A 3 year slo-mo crash with a cumulative 38% market loss. A 2008 loss of 37%. The compound growth during this stretch was 4.4%. But didn’t I just say my average loan rate was 6%? Yes. The difference was going into our retirement accounts. Not the matched portion, although that would certain tip the numbers in my favor. Just the regular pretax savings. And even with that disparity between my mortgage rate and the low market return, the 401(k) had $349K extra vs our $265K mortgage. What’s interesting to note here is that the money went into our retirement account at a marginal 28% tax bracket most years. But now, the withdrawals are at 15%. At a current rate of 3.5%, the mortgage payment is $1966, and if you do the math, it takes $2313 from the 401(k) to make this payment.

Two years have since passed, and the market in 2013 and 14 was very rewarding. A gain of over 50%. We ended 2014 with the mortgage at $233K and the calculated 401(k) extra funds at $453K. The interest deduction wasn’t part of my math, although it helps my numbers a bit. Instead of the whole payment being subject to the 15%, the first $8,000 is interest and, with some good planning, keeps us from hitting the 25% bracket.. No one should keep a mortgage “for the deduction” of course, paying a dollar to save 25 cents makes no sense. From where I sit, it simply means my 3.5% mortgage is actually 2.6%.

The fact that we hit our number while taking the mortgage payment into account, and not counting on social security which is still quite a few years away, is what lets me really sleep at night. Right now, I can’t say whether the mortgage will be paid off before we decide to move. Either way is fine by me. Paid off, our number drops, freeing up our savings for other endeavors.  A move would drop our cost of living, as we’re currently in one of the higher expense parts of the country.

The bottom line? 2 crashes over a 15 year span and the results are still in my favor. The key thing was that the difference was put into savings, not just absorbed into the spending portion of our budget. No regrets.

written by Joe \\ tags: , , ,

Sep 18

Have I lost my marbles? I hope not. Let me explain by starting with an analogy.
There’s a difference between treasure and a treasure chest. It’s not just a pedantic picking apart of words. Not understanding the  distinction is costing people a lot of money.

A 401(k) is a retirement account typically sponsored by an employer, although there is also a solo-401(k) option that self employed individuals can take advantage of. Until 2006, the 401(k) was strictly a pretax account, deposits from the employee would be deposited and save the tax at the time, grow tax deferred until retirement and withdrawn at (potentially) a lower tax rate. Employers’ matching deposits are also pretax and taxed on withdrawal. In 2006 the Roth 401(k) was introduced, allowing deposits to be made post tax, with the growth tax free if withdrawn after 59-1/2 or after separation from your employer after age 55.

treasure-chest

This is a high level overview but you see what’s missing? The Investment. I’ve only described the nature of the account, not the investments it contains. A 401(k) can have a variety of choices of investments. You may pick from a money market fund, short term bond fund, various stock funds including domestic and international. Some even allow you to shift funds to a broker portal where you can invest as you wish in individual stocks.

The distinction here is that the risk or reward has little to do with the 401(k) per se, and everything to do with how you choose to invest. In fact, you can made the same good or bad decisions in a regular brokerage account as you can in a 401(k).

This is my long-winded way of saying not to let the market volatility scare you out of proper long term retirement investing. I’ve had dialog with people who choose prepaying their 5% mortgage over making a matched 401(k) deposit, and when I point out the instant 100%  gain they can see in their retirement account, I hear they’d prefer the certainty of the 5%/yr interest saved over the risk their retirement account loses half its value as it did in the months leading up to March, 2009. The flaw in their reasoning is twofold. First, as I discussed, they need not be fully invested in stocks. The litmus test for how much of your account you should allocate to stock is to answer the question – If the market fell 50% over the next year, how would you react? If the answer is to sell at the bottom, you are too high in stocks. Second, your investments aren’t made all at once, but over decades. When you are buying into the market with each paycheck, your average cost is the average not last week or year, but the average over the last decade or more. And hopefully your sale price isn’t at the next bottom, but a few percent each year starting decades from now.

written by Joe \\ tags: ,

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.

401kgraphic01

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?

written by Joe \\ tags: ,

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.

stockreturn

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: , , ,