JoeTaxpayer

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?

The David (as I fondly call the entertainer Dave Ramsey) is known for his hyperbole. And his “my way or the highway” view on all things financial. One of his more memorable quotes is “No one ever says they got rich off of credit card points.” It seems to me that if I say so, and offer some supporting evidence, then he’s wrong. If he ever repeats himself, you can reply and tell him you know a guy that did. Let’s start here.

Above is a snapshot of my 529 account funded solely with the 2% cash back from my credit card. We use a credit card that offers 2% cash back on all purchases, and have had the card for nearly 16 years. It’s invested in an S&P index, so the number above includes the growth of the market. We have 2 years till my daughter goes off to college. Or 6 until her senior year. I’m hoping this account can grow to $40K and cover a full semester’s cost. That will make another topic for an article here.

In 2012, I wrote a guest post How I Made $4,000+ on a Cash Back Credit Card Offer. The exact number was $4550. That was a one time opportunity, for me, a way to take advantage of the institution we all hate, the bank that pays you .01% on you money, but charges you 5% on your mortgage, and a fee for every little thing. You can read all about it at the linked article.

Last, I’ve also had an Amex card that averaged over $500/yr in rebates for Costco and gas purchases, so another $10K on top of this. This all totals just over $50K, give or take.

There’s a site Global Rich List that puts wealth and income into perspective. I put in $40,000 and found

If instead of wealth, we look at income, how about I look at the $2000/yr I can withdraw from the $50,000, and add $2000/yr, the amount I’ve been getting back in rewards, so $4000/yr.

I offer this a bit tongue in cheek, as I know that $50,000 isn’t really rich, nor is $4000/yr living the dream. But $50,000 is still a chunk of change. If you look at how much we’ve saved for retirement in the US –

That $50,000 is more than 48% of those nearing retirement have saved. Did I really get rich on credit card points? We can debate that. But first, ask the 31% of 55 year olds who have less than $10,000 saved if an extra $50,000 would make them feel rich, and then decide.

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.

A message from my friend, Stephanie –

Hello JoeTaxpayer readers! I’m Stephanie, and I blog over at Graduated Learning.  For the past few years, Joe has been incredibly generous by donating to the Walk for Hunger, providing challenge funds toward my fundraising efforts.  It’s been great having that extra push to get family and friends to donate to this very worthy cause.  I’m excited that he’s offered up a challenge for my 4th year doing the Walk!