401k

Ask The Readers: When Did You Start Saving For Retirement?

Ashley Jacobs — Tue, 21 Jun 2011 10:36:27 +0000

Editor's Note: Congratulations to Kristina Wittchen, Guest, and Indymoney for winning this week's contest!

The topic of retirement comes up quite a bit in the personal finance world. With people concerned as to whether or not they will receive social security checks once they retire, more and more people are understanding the importance of making sure to save money so they can support themselves in retirement.

When did you start saving for retirement? Was it when you got your first job? When you turned 20, 30, or 40? What caused you to start saving? Or have you not started saving for retirement yet?

Tell us when you started saving for retirement and we'll enter you in a drawing to win a $20 Amazon Gift Card!

Win 1 of 3 $20 Amazon Gift Cards

We're doing three giveaways — one for random comments, one for random Facebook "Likes", and another one for random tweets.

Mandatory Entry:

Post your answer in the comments below

For extra entries (1 per action):

Go to our Facebook page, "Like" us, and leave a comment telling us you did, or
Tweet your answer. You have to be a follower of our @wisebread account. Include both "@wisebread" and "#WBAsk" in your tweet so we'll see it and count it. Leave a link to your tweet (click the timestamp for the individual URL) in a separate comment.

If you're inspired to write a whole blog post OR you have a photo on flickr to share, please link to it in the comments or tweet it.

Giveaway Rules:

Contest ends Monday, June 27th at 11:59 pm Pacific. Winners will be announced after June 27th on the original post and via Twitter. Winners will also be contacted via email, Facebook, and Twitter Direct Message.
You can enter all three drawings — once by leaving a comment, once by liking our Facebook update, and once by tweeting.
This promotion is in no way sponsored, endorsed or administered, or associated with Facebook.
You must be 18 and US resident to enter. Void where prohibited.

Note: Due to recent changes in Facebook's promotions guidelines, we have restructured the entry format of our giveaways.

Good Luck!

Tell us when you started saving for retirement and we'll enter you in a drawing to win a $20 Amazon Gift Card!

Written by Ashley Jacobs and published on Wise Bread. Read more Giveaways articles from Wise Bread.

4 Reasons Why a Roth IRA May be Better Than Your 401(k)

Darwins Money — Thu, 31 Mar 2011 11:36:08 +0000

Retirement planning is wrought with "rules of thumb," asset allocation recommendations, compound return assumptions, pension and/or Social Security income calculations, inflationary expectations, and more. Getting to "that perfect number" is an effort in futility unless you can see into the future with perfect clarity. So, aside from planning conservatively and starting early, a key consideration within your control now is the determination on where you direct your retirement dollars early in your career for the best net benefit in retirement. (See also: The End of the 4% Rule?)

The conventional wisdom on retirement savings has traditionally been that you should always invest in your 401(k) plan at least up to the limit of the company match. After all, who would argue against a free 100% return or whatever the match amounts to? But what about when you surpass that amount, which might only be the first 4-5% of income investments, if at all?

If your company matches funds up to say, 5% of your salary, but you could reasonably afford to invest another 10% of your income for retirement, would your money be better off topping off the same 401K(k) account or would you be better of investing the same funds in a Roth IRA account (noting the Roth IRA limit of $5,000 per person annually)? (See also: How to Make the Most of Your 401K)

Here are 4 reasons why those additional funds may well be better off in the Roth IRA.

Fees Matter!

With investors focused so much on stock market returns and volatility, the unsung hero of long-term investing is low fees. Even in the most aggressive conventional asset class, equities might reasonably be expected to return 9% per year including dividends. When you consider that inflation could reasonably average 3% or more over the ensuring decades, that's a net 6% return in real dollars. Now, factor in a difference of 1% in a high fee versus low fee mutual fund and the difference in compound returns really adds up!

It's now becoming common knowledge that company-sponsored 401(k) plans often offer sub-par mutual funds that are both high-fee and generally don't even match their benchmarks. Contrast that with the ability to select a low-fee ETF or mutual fund in a self-directed IRA account and right off the bat, you're looking at improved returns over a prolonged period of time. Personally, I have funds in my company plan with expense ratios in excess of 1% while Vanguard offers many mutual funds closer to 0.10%. Over the 30 years I have until retirement, that 1% difference can add up to six figures or more!

More Options

Aside from being presented with higher fee options, 401(k) plans often offer only a single choice in a given asset class. Your plan might have all actively managed mutual funds based on say, Large Cap US, Small Cap US, European Growth and a Bond Fund. What about if you want to diversify further into Emerging Markets, commodities or even various high yield investments which can flourish in a tax advantaged plan since income accrues untaxed? You are strictly limited in your 401(k) plan while you have thousands of investment options in a Roth IRA ranging from mutual funds to ETFs to stocks to bonds (see the risks/benefits of ETFs over other investments). You can even own gold in an IRA, not that I'm an advocate.

A friend of mine sells mutual funds for his firm to corporate clients for their 401(k) plans. He said what he hears over and over is basically a conservative mantra: "We're not looking to be superstars here. We need to avoid being sued. We aren't going to offer our employees exotic or volatile funds." Companies aren't in the business of providing you a lot of options. They're trying to just keep up with the competition and offer a "decent" total benefits package which often includes a modest match and some funds to choose from. But probably not the range of funds you'd invest in if you had the choice — like you do in a Roth IRA you set up yourself.

Tax Rates Are Likely to Rise

The tradeoff with a 401(k) versus a Roth IRA is that with the 401(k), while the amount you invest is deducted from your taxable income in the current year, you have to pay taxes on the withdrawn amount in the future. Conversely, with a Roth IRA, you invest now with after-tax funds, but regardless of tax rates in the future, those earnings can be withdrawn tax-free. So, it often comes down to an assumption about tax rates.

The "conventional wisdom" had always held that you're probably in a higher tax rate today than you will be in retirement because you won't be working the same full-time job and might only be collecting Social Security and some retirement income. However, this whole notion of tax rates needs to be reconsidered.

See, it is a mathematical certainty that the US can't continue to meet its debt obligations without increasing taxes, especially on the upper-middle class and higher. Unless your income is very low on the spectrum (in which case, the ability to invest excess funds to this degree may be limited), there's a decent chance that in the coming years, tax rates will begin to increase. After all, we're in the midst of a temporary, controversial, negotiated "Bush-era" tax rate regime right now. But the political will and fiscal ability to make the current tax rates permanent just isn't there.

Additionally, while my income may decrease in retirement, so will my deductions. I will no longer have a mortgage interest deduction and I won't be getting state tax deductions for 529 Plan Investments. Therefore, if you assume that your effective tax rate in retirement may be higher, or even just roughly equivalent to your present tax rate, then the "conventional wisdom" no longer pushes the equation in favor of 401K(k) investing and the other considerations above should take precedent.

Flexibility for Emergencies

Not that you want drawdown of your principal as a retirement planning philosophy, but in the event of extreme need, one can withdraw the principal portion of IRA contributions without penalty, whereas in a 401(k), there's a 10% penalty incurred plus the taxes of course, since they were deferred initially. There are some provisions of hardship associated with 401(k) plans, but the restrictions are rather onerous whereas the Roth IRA is flexible. This shouldn't be an up-front expectation that you'll be withdrawing funds prior to retirement, but it might be comforting to know that there's added flexibility in that portion of your retirement assets, as opposed to having everything in the 401(K) which would be subject to penalties and taxes.

The reality is, nobody knows what's going to happen 20 or 30 years from now. But the priorities of diversification, minimizing expenses, and optimizing your tax liabilities may well push you more in the direction of Roth IRA contributions over 401(k) contributions once you exceed a company match.

Note that 403(b) and other equivalent plans have similar attributes to the 401(k) and can be used interchangeably throughout.

Where do you invest extra retirement funds?

Written by Darwins Money and published on Wise Bread. Read more articles from Wise Bread.

Plan Now for Your 2011 Retirement Plan

Barbara Weltman — Wed, 24 Nov 2010 18:52:12 +0000

Link:

http://www.openforum.com/idea-hub/topics/money/article/plan-now-for-your-2011-re...

While 2010 isn't over yet, it's not too early to think about setting up a qualified retirement plan for 2011 if you don't already have one in place. Getting an early start is especially important if you have employees. This will give you time to select the plan that best meets your business and retirement-plan goals. It will also give employees an opportunity to decide whether to participate and how much of their wages to contribute if you choose the type of plan based on employee contributions, such a 401(k) plan.

Why have a retirement plan?

A qualified retirement plan allows owners to shelter company profits while saving for their personal retirement. It also creates a valued employee benefit to attract and retain good workers.

Of course, there is a cost for these benefits. The company must include employees in the plan, and to a greater or lesser extent, make contributions on their behalf on a nondiscriminatory basis; the plan cannot be limited to owners and key employees. There is a cost not only for company contributions, but also for administrative plan-related activities, such as filing annual information returns if required.

If a small business with no more than 100 employees sets up a qualified retirement plan, it can take a tax credit of half of certain administrative costs (such as educating employees about the plan) up to a credit of $500 per year for the first three years of the plan. However, to claim the credit, the plan must cover at least one person who is not an owner or owner's spouse.

Which plan is right for you?

There are many types of qualified retirement plans to choose from. The following are the key types of plans popular with small businesses (discussed in IRS Publication 560, Retirement Plans for Small Business), and their features and advantages. There are a number of variations on these basic types of plans.

Profit-sharing plans
These plans are funded solely by employer contributions, enabling businesses to offset their profits by deductions for contributions on behalf of employees. If a business isn't profitable, it doesn't have to make contributions.

Simplified employee pensions (SEPs)
These are a variation on profit-sharing plans and are widely used by small businesses. The advantages of these plans are no annual filings of information returns for the plans and the fact that they can be set up and funded as late as the extended due date of the return for the year to which they relate (e.g., a 2011 plan of a business owner with a filing extension can be set up and funded by October 15, 2012).

401(k) plans
These plans are funded by employee contributions made on an elective deferral basis (employees agree to add part of their salary and aren't taxed on this contribution). Employers may want or be required to contribute to employee accounts; employer contributions are deductible by the business.

SIMPLE plans
These function much like 401(k) plans, but have lower limits on the amount that employees can contribute. Also, if they are set up as SIMPLE IRAs, there is no annual information reporting as there is for 401(k) plans.

Defined benefit plans
This is a pension funded by employer contributions. The plan promises to pay a set benefit at retirement, and contributions are actuarially determined to meet this benefit promise. For businesses with owners who are highly paid professionals and few or no other employees, this plan can provide significant retirement benefits and tax-sheltering, all or most of which go to the owners.

What's new for 2011?

The IRS has released the limits on contributions and benefits that will apply to qualified retirement plans in 2011; because of low inflation, they are the same limits that applied in 2010. Key figures of note:

Maximum contribution to profit-sharing and SEP plans: $49,000
Maximum benefits provided by defined benefit (pension) plans: $195,000
Maximum amount of compensation taken into account in figuring contributions and benefits: $245,000
Maximum elective deferral to a 401(k) plan: $16,500 (plus an additional $5,500 for those at least 50 years old by the end of 2011)
Maximum elective deferral to a SIMPLE plan: $11,500 (plus an additional $2,500 for those at least 50 years old by the end of 2011)

What to do now?

It's wise to meet with a tax adviser to discuss your plan options and which type of plan works best for your personal situation next year. For example, if the company has a small staff, you may want to use an automatic 401(k) plan so that you, as the owner, can maximize your personal contributions. With this type of plan, employees are automatically included with a set contribution amount unless they opt out or change their contribution amount; the company must make certain minimum contributions to avoid certain complexity. The sooner you make plans, the sooner you and your staff can begin to save for retirement on a tax-advantaged basis.

Written by Barbara Weltman and published on Wise Bread. Read more Small Business Resource Center articles from Wise Bread.

Delayed Gratification and the Secret to Will Power

Jessica Bosari — Thu, 16 Sep 2010 12:00:12 +0000

Retirement saving, and indeed saving in general, is nothing more than delayed gratification in action. We all want to save something for the future, and even a small amount invested today can make a significant difference in our retirement funds tomorrow. But trying to defeat our desires for instant gratification outright is often a dead-end endeavor. Depriving ourselves of the things we want goes directly against the grain of some very powerful impulses.

As human beings, we are emotional and rational creatures. Reason is what sets us apart from most animals. But we are not always good at separating our emotions from logic. In fact, when an incident occurs that influences our emotions and subsequent decisions, we don't even recognize it. Psychologist Jennifer Lerner told CBS's 48 Hours,

We've never succeeded, never, in having people recognize the irrational influence of incidental emotion.

So our emotions influence our decisions to save or spend, yet we are very bad at recognizing when that happens.

Will Power Has Nothing to Do with It

Enter will power, the strength to hold to your convictions. We often complain that we lack will power. We look at Olympiads and their amazing feats, marveling at the display of strength motivated by the power of their own desires. But most of us don't have that kind of single-minded drive. Most of us have many different competing desires to manage. That's why will power doesn't work for most people. The good news? Will power is a skill that can be learned.

In his article, "The Secret of Self Control," Jonah Lehrer described an experiment done by Walter Mischel, a Stanford professor of psychology, that took place in the 1960s.

A researcher then made Carolyn an offer: she could either eat one marshmallow right away or, if she was willing to wait while he stepped out for a few minutes, she could have two marshmallows when he returned. He said that if she rang a bell on the desk while he was away he would come running back, and she could eat one marshmallow but would forfeit the second. Then he left the room.

Gimme that Marshmallow!

As it turns out, the kids who could wait for two marshmallows grew up to be well-behaved teenagers with good test scores. The ones who rang the bell were more likely to score poorly on tests as teenagers and to have behavioral problems. As these children grew into their 30s, it became obvious that the differences extended much further. Those who could wait for the marshmallow were wealthier and more likely to make good decisions.

When researchers observed the differences in behavior, it seemed that the children who stared directly at the treats, as if to focus intently on the goal, had a harder time resisting. Those who sang songs to distract themselves while they waited were able to hold out for the two-marshmallow treat. It was not a matter of defeating will power or staying focused on the goal. It was all about forgetting the problem and simply waiting for the outcome.

How to Get what You Want without Squirming

Mischel's research also uncovered a shortcut for learning delayed gratification skills. He and colleagues used simple mental tricks to help the children. They pretended the marshmallow in front of them was not real, only a picture. This mental exercise allowed kids who couldn't wait 15 seconds for one marshmallow to wait 15 minutes for two marshmallows. Mischel believes that

Will power is just a matter of learning how to control your attention and thoughts.

Using tricks like this can make it easier to see the big screen TV, but to wait until you can pay cash to buy it. That leaves more money in your savings account because you aren't making interest payments on a loan. Distracting yourself can also help relieve the stress of not having what you want right now. When you learn to let go, if only temporarily, you are more likely to get what you want in the end. It'll be easier to enlist smart strategies for future savings, such as:

Pay yourself first. In personal finance, the concept of saving by removing the temptation to spend has come to be known as "paying yourself first." In other words, electronically saving or investing directly from your bank account or paycheck before you have a chance to put your hands on the money.
Use your 401k plan. Most mid- to large-size employers offer 401k retirement plans, into which investments are made directly from your paycheck. Your potential returns get an additional boost from tax savings — funds are deducted from your taxable income before tax due is calculated — and matching contributions directly from the employer for a certain percentage of your investment. Furthermore, employers are increasingly taking the concept a step further by "auto-enrolling" employees in their plans once they become eligible.
Enroll in an IRA. Those who don't have access to an employer-sponsored retirement plan can employ the same strategies in an Individual Retirement Account (IRA). Simply provide your bank account information and investment instructions on your application. Most fund companies reduce or waive their initial investment requirements when you establish an automatic investment plan.

Once you've gotten started, strive to increase the percentage of your deductions. Use your new skills to delay purchases and instead put some money into retirement and some into a short-term savings account to buy the things you want. Most people find that, once their automatic investing has started, they forget about the money they would otherwise spend.

Guest Post Blurb:

This is a guest post by Jessica Bosari. Jessica is an Internet Copywriter and Blogger. She manages and edits the money-saving-tip site Billeater.com as well as her own blog. You may also be interested in these articles by Jessica:

Written by Jessica Bosari and published on Wise Bread. Read more Personal Development articles from Wise Bread.

3 Easy Steps to Take for a Better 401k

David Ning — Tue, 08 Jun 2010 11:00:09 +0000

I was recently invited to a small business 401k checkup meeting, where we talked about how the company's employees were participating in its plan, the overall performance, and fund allocations.

When the representative suggested to hold a seminar on asset allocation, I asked whether she could separate the sessions into different age groups. She said "Oh, that's not a problem. I think that's a very clever idea, but no one has ever asked me to do it this way." The right mix of stocks and bonds is different for someone early in their career versus someone who's about to retire. I'm sure you know this, but it seems like no one else in your company does.

Not the person sitting beside you, not your boss, and not HR. No one knows much about asset allocation other than you. Yikes...

The response was rather surprising. You'd think that everyone would know about asset allocation by now, but that's simply a false assumption. Being immense in personal finance literature has its disadvantages, as we often overlook the fact that most of the general public knows very little about basic personal finance and investing principles.

As a savvy investor who has a much better chance of achieving financial freedom, here's how you can help everyone around you.

Ask

All 401k plans are required to be looked at and discussed on a regular basis. Chances are good that representatives from the company managing your plan comes regularly too. Ask your plan administrators to have the representatives (or bring in experts) give seminars about your plan, the benefits of saving and investing for the long term.

Most of the information they give may be familiar to you, but a refresher is always good even if you already know every tip there is to know. If anything, reminders will make you think about your retirement plan more, which can only help.

Suggest

Offer suggestions to others on how they can contribute to their plan, and perhaps even come up with a step by step plan to navigating the 401k plan web interface. The more comfortable your fellow workers are with the plan, the more likely they will commit more of their salary into it. The benefit to you may not be immediate, but bigger size 401k plans tend to have better expense ratios, which helps everybody in your company.

Monitor

The reality is that most 401k plan administrators have many other more pressing jobs than thinking about the company's 401k plan. As a result, the 401k plan is usually an afterthought of an afterthought. If you think about how important even a fraction of a percent makes in your plan over the years, the likely neglect of your primary retirement vehicle sounds ludicrous. By having more people talk about the plans at work and showing interest, it's that much more likely that your plan administrators will keep a closer tab of what could be done to improve the overall function and performance.

It's not what you expect, but what you inspect. Help keep the plan in the forefront of your plan administrator's minds, and good things will follow. Having said that, I have got to ask: Have you maxed out your IRA yet?

Written by David Ning and published on Wise Bread. Read more Retirement articles from Wise Bread.

Clever Tax Move for the Un- and Under-Employed

Philip Brewer — Fri, 26 Mar 2010 14:00:12 +0000

There are a lot of people who used to have a good-paying job but who have been unemployed or underemployed for more than a year. If you're one of those people, here's a clever tax move that can permanently cut your future tax burden.

If you used to have a good-paying job, you probably have some tax-deferred savings in an IRA or 401(k). You'll have to pay taxes on that money whenever you take it out.

So, here's the clever part: If you're unemployed or underemployed this year, your income is probably very low. If your income is low enough that you'll owe little or no income tax, seize this opportunity to shift a few thousand dollars from your IRA to your Roth IRA. The money will be taxed, but the tax will be near zero. And once the money is in your Roth, it'll be able to grow tax-free, potentially for decades, and then still be tax-free when you withdraw it. You'll have already paid the tax on it, only the tax will have been zero.

Of course, this tax move only works for a narrow slice of people, those who both:

Have money in an IRA
Have a very low taxable income for this year

But for that narrow group, the amount of tax savings could be substantial.

Note that it's too late to do this for last year. It is not, however, too early to start planning for this year. In particular, if your money is still in your former employer's 401(k), do a rollover to an IRA now, so that you'll be able to transfer the money to a Roth IRA before the end of the year.

How much should you move? That's kind of tricky. Ideally, you want to move as much as you can without having to pay any extra tax. But that's not so easy to calculate — it's about as much work as doing your taxes (and don't forget to consider state as well as federal). But, if you can steel yourself to crank through the numbers, the potential exists to permanently avoid ever having to pay the taxes that were only deferred when you put the money into an IRA or 401(k).

Especially for people forced into premature retirement, whose incomes are low now but will be higher once their pensions and social security kick in, this can be a great move.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Getting Fired? Ask One Question to Get Free Money

Carlos Portocarrero — Tue, 02 Mar 2010 17:00:02 +0000

Getting fired is never easy. There are a whole bunch of emotions that you'll experience: from anger to sadness to very serious concern for your future.

All valid emotions. None of them will do you any good.

But a few weeks ago I discovered a question that can actually make you some money if you ever get fired. It has fast become my number one "if you get fired" tip.

If you get tapped on the shoulder and asked to step into HR's office, don't forget to ask them this one, very important question:

Will you give me the unvested portion of my 401(k) account?

What does it mean?

If you've been a responsible employee, you've been contributing to your 401k account — at least up to the company match. But most companies have a vesting schedule — which means that money they "give" you isn't "yours" until you've worked there for X amount of time.

So after one year, you only "get" 10% of the total they've matched. After three years, maybe it's around 20%, and so on. The longer you stay, the more of it is yours.

But technically that money isn't yours until it's vested.

But a lot of employers are willing to give you the unvested portion of your 401(k) account if/when you're being let go.

Especially if it's not performance related and they just need to downsize. It's not that big of a deal to them and in an effort to make these kinds of moves as painless as possible, there is a good shot you'll get this money.

The worst thing that can happen? They say no.

Has anyone out there had success with this?

Written by Carlos Portocarrero and published on Wise Bread. Read more articles from Wise Bread.

The 10-Step Staircase to a Comfortable Retirement

Steve Klingaman — Thu, 04 Feb 2010 18:00:13 +0000

The secret to saving enough for retirement is simple. Start early and increase the amount you save over time. For many people the hardest step on the journey is that first one. Think of saving for retirement as climbing a staircase. Step One is to save enough money each year to receive the full employer match available to you under your company 401k plan. Often, this is around six percent of salary. (See also: How to Make the Most of Your 401k.)

Why is this step so important? One, it gets you in the game. Two, the employer match is free money. Depending on the generosity of your company plan, the employer match could equal anywhere from a 25 percent return on investment to a 100 percent return. Nowhere else in the investment universe do you find returns like this so easy to attain.

In order to get started, you may need to construct a budget and cut some expenses. Two of the usual suspect categories are a) “walking around money,” the kind you withdraw from an ATM or put on your debit card, and b) take-out food. Master these two categories and you will save enough to get started.

One Step a Year

Once you are saving something, plan to increase the amount you save by one percent a year. Make a pact with yourself that you will do this like clockwork every year for ten years, until you are saving 16 percent of your salary. Think of it as climbing a staircase one step at a time, one step per year. If you start saving six percent a year at the age of 30, you will reach your goal by the age of 40. By that time, in comparison with the average saver, you will be at the top of the class.

This regimen may not make you rich in retirement, but it should easily put you easily in the top 10 percent of American savers. According to the 2008 Employee Benefit Research Institute survey, Americans in their 40s with a job tenure of between 10 and 20 years have an average of $65,512 in their 401k plans.

If You Start Early, Time is on your Side

Remember: the earlier you start, the easier it gets. Dollars put away while you are in your twenties have up to 10 times the earning power of dollars saved later.

If you started saving six percent of your salary per year at the age of 25, based on a salary of $30,000, an employer match of 50% and an annual return of 8%, and you just left that arrangement on autopilot. Even without a raise throughout your life, you would amass $750,000. This is far more than the average 401k contains today. But our method combined with your growing salary may net you, believe it or not, something in the range of $2 million dollars. But if you wait until you are 40 to start saving, even if you save a much higher percentage of your income, odds are great you will never crack a million.

If you want to run a few numbers yourself, Bloomberg and CNNMoney offer online retirement calculators. Neither of these, unfortunately, allows you to model the stair-step method featured here.

Adjust Your Allocations as You Age

Consider sensible, yet aggressive, market allocations for the long haul. You do not need to restrict yourself to “investing your age” in stocks. This is an old rule that says whatever your age is, subtract it from 100, and that should be the percentage you have in stocks. That is too conservative if you are only 30 or 40 years old. According to US News, retirement savers in their 30s, invest roughly two-thirds of their portfolio in stocks. That’s too conservative. Many experts say you can put as much as 80 or 85% of your money in stocks at the age of 30. Find your comfort zone and then, as you get older, consider transferring some percentage of your holdings to your bond fund every year that stocks rise.

On the other hand, 100% in stocks is never appropriate. Studies show that a 90-10 stock-bond allocation is appreciably safer than keeping it all in stocks, while the investment return is just a fraction of a point less than an all-stock portfolio. And an 80-20 split doesn’t earn a lot less than a 90-10 split. Moreover, of course, it is less risky still.

Use Index Funds

John Bogle, the pioneering founder of Vanguard Investments, observed years ago that most people give up a good bit of their potential investment returns by chasing returns of previous winners and spending too much on investment costs.

Instead of trying to pick winners (which no one can do reliably over time), Bogle suggested the investor buy the entire market through an index fund and trade only to rebalance allocations for annual investment earnings and long-term risk adjustment. Thus, the birth of the couch potato portfolio—the amazing breakthrough designed to prevent the investors from becoming their own worst enemies.

Unfortunately, many companies do not offer index funds in their 401k plans. If this is the case, ask your company to introduce one or more. Mention Vanguard as an example. Their premier index fund is called the Vanguard Total Stock Market Index Fund. Other companies offer similar products. You will need a bond index fund, too.

Wise investors invest in international markets as well as U.S. stock funds. Often, you will see 20 to 25% of the amount invested in stocks allocated to offshore funds. There are other wrinkles as well, but you can get started with just three funds: a domestic stock index fund, an international fund, and a long-term bond index fund.

One important tip is to rebalance your portfolio at least once a year. If stocks have a good year and increase by 10 percent, your 75-25 stock-bond allocation will be knocked out of whack. It may look like a 77-23 portfolio by the end of the year. Transfer some of those earnings back to your bond fund to regain the 75-25 target allocation. This forces you to do what only the most brilliant investors do: buy low and sell high. (Other than rebalancing, resist the urge to tweak your allocations.)

Discipline helps in tough times. Even if your employer suspends the match, as many have done during the economic meltdown, maintain your Step One investment. Oh, and never borrow from your plan. Repeat: do not touch this money during your working years. You are better off taking a temporary or second job rather that raiding your nest egg. If you do, chances are very great you will never make it up. So make imminent starvation the bar for raiding the piggy bank.

Defined contribution retirement plans, or 401ks, are pretty much the only game in town when it comes to saving for retirement these days. Learning to invest wisely and sufficiently in a 401k will put you in the top echelon of individual savers. It will make you feel better about your money life. Saving for retirement is one of the Big Three economic commitments in life: retirement, house, education. So give it your best shot — one step at a time, one percentage point a year.

Guest Post Blurb:

This is a guest post by Steve Klingaman, a nonprofit development consultant and nonfiction writer living in Minneapolis. Read more by Steve:

Written by Steve Klingaman and published on Wise Bread. Read more Investment articles from Wise Bread.

Don't Despair Over Small Retirement Savings

Philip Brewer — Wed, 23 Sep 2009 13:00:03 +0000

If you quit checking your 401(k) balance last year, because the market crash made it too depressing, now might be a good time to take a fresh look. It'll still be well down from the peak, but it's probably recovered quite a bit from the low. However small it may be compared to some imagined goal, don't underestimate the value of any amount of retirement savings.

My brother just told me about a colleague—a college professor approaching retirement age—who suffered so badly in the crash that his entire retirement savings were not much more than one year's pay. "Obviously," my brother observed, "He's not going to be retiring on that anytime soon."

The fact is, though, there's a big difference between "small" and "insignificant" when it comes to money. If you're earning, let's say, $80,000 a year (which a full professor approaching retirement might well be) and your savings are only $80,000, it's easy to imagine that your retirement savings are insignificant. It's not true, though.

A capital sum of $80,000 will support spending of $260 to $330 a month for the rest of your life (and probably forever—see my post How much can I spend in retirement for a description of the 5% and 4% rules).

Now, somebody who's been living on $80,000 a year is not going to support themselves on $300 a month—but that doesn't mean that $300 a month is insignificant. It might pay your property taxes, or your home maintenance expenses, or your utility bill. (If you have a small, well-insulated house in a low-tax community, it might pay all three.)

If you have nothing else to retire on, this is probably too little—but hopefully your retirement is not dependent on just your retirement savings, but instead gets a boost from other savings, physical capital (such as a house), pensions from previous employers, social security, intangible capital (such as a copyright on a book), and so on. Most especially, of course, your retirement is based on your ability to save more money at your regular job before you retire, and then your ability to continue to earn some money after retirement.

Finally, I'd like to point out that your expenses in retirement have only the most tenuous relationship to your pre-retirement income. Yes, those "can you retire" calculators all ask about your income and then assume that you need to replace a large fraction of it—but that's just stupid. In retirement you need to fund your expenses, not your income.

Someone approaching retirement ought to be about at the peak of their earnings—which to my mind ought to mean that their expenses are rather less than their income. It's one thing for a 20-something just out of college with a low income and a high student loan burden to be spending every cent of his or her take-home pay. For a 60-something college professor, expenses ought to be quite a bit less.

The difference, of course, is the money that's available for investment. But that's the less important part of the equation. More important is that a low cost of living means that you can retire without having to replace your entire income. And if that's true, even a modest amount of savings can support your retirement.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Optimize Your IRA and 401(k)

Philip Brewer — Wed, 29 Jul 2009 20:00:11 +0000

Your IRA and 401(k) (or 403(b) if you work for a non-profit) are great tools for deferring taxes, and have other advantages as well. But because they're labeled "retirement" accounts, people are much too likely to put the wrong investments in them. Here's how to use them correctly.

Because of rules designed to discourage people from taking money out until they approach retirement age, people assume that they ought to put their "long-term" investments in their 401(k). But that's the wrong way to think about it.

The key difference in a 401(k) or IRA account is not that it's supposed to be for your retirement. The key difference is that money that goes into the account--and money earned in the account--is tax deferred. If you let the fact that the accounts are called "retirement" accounts influence what assets you hold in them, you're unlikely to make maximum use of their key feature--and that amounts to throwing money away.

Use that tax deferral!

There are two steps to optimizing your various retirement accounts. The first is to get some money into them, and the second is to put the right investments into the right accounts.

First of all, you probably want to put as a big chunk of your regular income into your 401(k), as you can.

I say "probably" because there are a few reasons why you might want to limit how much money you put in your 401(k):

Your income is very low. If your income is low enough that you're being taxed at 10% or less, there's a pretty good chance that you'd pay higher taxes when you take the money out of your 401(k) after retirement.
Your income is very high. Both the IRS and your company limit how much money you can tax defer if you have a very high income.
Your employer's plan is crappy. Some plans have high fees or poor choices of investments.
You want to save money outside the plan, such as because you want to use it before you're retirement age.

Of course, if your company still provides a corporate match, that plays into the decision as well. I've got a post on when NOT to put money in your 401(k) that talks about those issues in some detail. To what I'd say there I'd only add that federal income tax rates are currently at generational lows. That, combined with the current level of the deficit, suggests to me that future tax rates are likely to be higher than current tax rates--another reason why you might not want to put all your long-term savings in your 401(k).

Separate asset allocation from account selection

The allocation of assets among your various long-term goals is a completely different step from the selection of which account should hold which asset. Understanding this can add substantially to your wealth.

You probably have several long-term goals. Retirement (including early retirement) is one, but anything that requires years of saving qualifies as a long-term goal. (Examples: college savings for a young child, money to start a business, your dream home, a round-the-world cruise).

Investments for all your long-term goals can and should be managed together. All your assets support all your goals; you just confuse yourself if you start thinking that these stocks are for retirement while those other ones are to put a new roof on the house someday.

So, step one is to figure out your ideal asset allocation. This probably includes putting a large fraction of your investments in a broad-based, low-cost stock index fund, but may include investments in many other asset classes: mutual funds that invest in foreign stocks or dividend-paying stocks (or direct investments in such stocks), bonds, real estate, gold, silver, other commodities, etc.

Only after you've figured out how you want to invest your entire portfolio do you want to figure out which accounts should hold which investments.

Choosing compartments

The key to this step is to put income-earning investments in tax-deferred accounts.

Your asset allocation may include an investment in non-dividend paying stocks. They'd be part of a long-term investment strategy whose purpose is to produce growth over the next 20 or 30 years--but just because they're long-term does not mean that they should go in your 401(k)! Quite the reverse: a non-dividend paying stock that's a core holding in your portfolio should be in your regular brokerage account. If it does well you can go on holding it for years and years and won't have to pay any taxes until you sell--and when you do sell, you'll owe taxes at the low capital-gains rate.

Holding that investment in your retirement account would be crazy. First, since you already don't owe taxes while you're holding it, you'd get no benefit from the tax deferral. Second, when you withdraw money from a retirement account you have to pay taxes on it as regular income--losing the favorable tax treatment for capital gains.

(It doesn't work out any better if the investment does poorly--in your regular brokerage account you can use a capital loss to offset other gains before paying taxes, but losses in a retirement account are just losses.)

You don't want the compartment decision to drive your asset allocation--you already decided what investments you wanted to hold. But those assets should end up in compartments based on tax considerations. Interest-earning investments like bonds go in tax-deferred accounts. So do investments with frequent turnover--if you make trades in your regular brokerage account you have to pay taxes on your profits every year.

Dividends are a special case. Currently dividends are receiving favorable tax treatment, so you're probably better off keeping most dividend-paying stocks outside of your 401(k) at the moment. This is likely to change, though, so you'll have to monitor the situation.

If you have a good 401(k) plan with lots of low-cost fund choices, it should be easy to hit your target allocation with most of your interest-earning investments (and investments that you might trade actively) inside the plan.

Limitations

In an ideal world it would be straightforward to allocate things to the different categories: You'd put the things that earned interest into your 401(k) and IRA while keeping things that produced capital gains (and currently dividends as well) in regular accounts.

In the real world there are a bunch of constraints on that, the biggest being that many people, especially younger folks, have practically their whole wealth concentrated in their 401(k).

This happens almost automatically: You get a job, you direct enough money into your 401(k) to get the full corporate match (back when companies actually paid a corporate match), and then you spent most of your take-home pay. You can't hold your stock portfolio in your brokerage account (where you'd get the maximum tax advantage of the capital gains and dividend tax breaks) because you just don't have enough money outside the 401(k).

This and similar real-world considerations are going to limit your ability to get this exactly right--and that's to be expected. The important thing is to base your asset-allocation decisions on your best analysis of your goals and your expectations for the future. Below I've got a few tips for dealing with specific situations.

The main limitation on your ability to optimize your 401(k) plan has to do with the choices your employer offers within the plan. Happily, you can work around even a pretty mediocre plan's limitations, as long as you at least some of your long-term savings outside your 401(k).

First, take a close look at the investment choices you've got and compare them to your desired asset allocation. Maybe there's no bond fund, but there is a balanced investment fund that's half-and-half stocks and bonds. If you wanted 20% in bonds you could get that by putting 40% of your money into the balanced fund. (That would also put 20% of your money into stocks--which is fine, as long as your stock allocation is at least 20%, which it probably is.)

Second, where you really can't find the investments you need within the plan (no international fund, perhaps, or no gold fund) you have to cover that fraction of your asset allocation elsewhere--which is also fine, as long as you have some of your long-term investments outside the plan. If the investment is one that ought to be tax-deferred, see if you can't buy the appropriate asset within an IRA.

Generally, make hitting your asset allocation your number one priority. Maximum tax efficiency is a secondary consideration--but to the extent that you can keep your bond investments (and any investments where you make frequent trades) inside a tax-deferred plan, you'll come out ahead.

As a secondary matter, start saving some money outside your 401(k). As the sum grows, use it to invest for capital gains (and, for however long they remain tax-advantaged, dividends)--and simultaneously shift your 401(k) toward interest-earning investments that make maximum use of the 401(k)'s tax advantages.

For most people this will probably be a long-term problem: Unless you become quite wealthy, your 401(k) will always be larger than the amount of money you want to hold in bonds. But that's not a big problem. Just stick with your asset allocation and emphasize capital gains and dividends outside the 401(k).

Using a Roth

A Roth IRA is a special case. If you follow the rules (wait until your Roth is 5 years old and until you're 59-and-a-half), you can avoid paying any taxes on money earned in a Roth.

The upshot is that most of these issues don't really apply to a Roth. Just invest according to your asset allocation and don't worry about it.

Remember that tax rates always change (and everyone's individual tax situation is different), so be sure to check and understand how the rules will actually apply in your case.

Whatever mix of retirement accounts you end up using, don't let the fact that they're called "retirement" accounts distract you from the essential features that distinguish those accounts: the tax advantages. Taking maximum advantage of those features can add significantly to your wealth over the next few decades.

[Update 6 August 2009: This post was included in the Carnival of Personal Finance.]

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Retirement accounts and money to spend

Philip Brewer — Wed, 08 Apr 2009 17:54:54 +0000

Everybody knows that retirement accounts like 401(k)s and IRAs offer great tax advantages (and once upon a time--and maybe again someday--a corporate match). But people who have plans to spend the money before they reach retirement age worry about the restrictions on early withdrawals that come with the various retirement plans. Here's a cheat-sheet for working the angles.

There are two different points where you need to do your considering: when you're making your saving and investing decisions and are thinking about where to put the money, and then again when you're making the spending decisions and are thinking about where to take the money from.

Start your thinking by dividing your goals for the savings (other than retirement at full retirement age) into three categories: major purchases, emergency funds, and early retirement.

Major purchases

Your retirement accounts are generally a poor choice for money that you're planning to spend on things like buying a house or a car, sending the kids to college, or taking a lavish vacation.

You can borrow from your 401(k) for the down payment on a house, but you're combining the big problem with such borrowings (losing your job means you have to pay the money back in 60 days or owe taxes and penalties) with a big bite out of your retirement savings.

Better is to save for these goals outside your retirement plan. In some cases (such as college savings) there are other tax-advantaged plans that are better suited for the purpose.

One special case is funding your own college expenses. You don't have to pay the 10% penalty on money that you withdraw from an IRA to pay your own college expenses, so an IRA is a perfect place to save money if you're planning to go back to college.

Emergency funds

Money in your retirement account is available to handle emergencies to a very limited extent. Generally, it's available two different ways. You can borrow against your 401(k) and you can withdraw your contributions (but not your earnings) from a Roth IRA once the plan has been established for 5 years.

Making use of either of these options is generally a bad idea--but in an emergency, sometimes it's a matter of bad versus worse.

You ought to have an emergency fund that's not in retirement accounts. But it's worth understanding that the money isn't completely unavailable, especially if that makes it easier for you to put a bit more aside.

Early retirement

Here's where way too much brainpower has been wasted by people who plan to retire early and worry about coming up with cash to fill the gap between the date they retire and the date they can start taking money out of their 401(k) or IRA.

First of all, if you're really retiring, you can take money out of your retirement account. There are rules to follow--you have to arrange to take a series of payments calculated to last the rest of your life--but that's exactly what you'd want to do if you were actually planning on living on the money.

Second, if your goal is to retire early, you're almost certainly going to be hitting the maximums on your retirement accounts and having to save some after-tax money anyway.

The upshot is that maximizing your retirement savings is entirely compatible with early retirement. It probably won't be enough for early retirement, but maxing out every retirement savings option you've got is a great start.

I wrote a while back out what order to max the accounts out in.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Funding your 401(k) when you're in debt

Philip Brewer — Tue, 11 Nov 2008 12:23:31 +0000

If there are two pieces of financial advice that get hammered more often than any others, they're "Get out of debt" and "Put enough in your 401(k) to get any corporate match." With times getting tough--making both debt reduction and saving seem more urgent than ever--how do you balance those two choices?

To figure out the right answer, you need a couple of pieces of information: You need to know what the corporate match on your 401(k) is and you need to know what the interest rate on your debt is.

Corporate match

During the good times, many companies offered a 100% match--one hundred cents on the dollar for the first three or six percent of your salary that went into the 401(k). Others offered a 50% match. Some had a tiered match, offering 100% for the first few percent and then a 50% match for the next few percent. Get the rules from the plan documents or your company's internal communications regarding the plan.

Be aware that companies have been cutting their 401(k) matches, as a way to cut expenses in the face of the current hard economic times. So, make sure you're getting the latest information, and also keep alert to future changes. If the match changes, it could easily change the whole calculation.

Cost of debt

Track down all the kinds of debt that you've got--credit cards, personal loans, car loan, mortgage, etc. You're looking for total cost of credit, so you not only need to know the APR, you also need to include any fees that you end up paying.

Credit card companies in particular have been raising the rates they charge. They've also been becoming more aggressive with their use of the "penalty" rates that they charge people who have missed a payment--or simply have a high debt load.

What you need is the percentage rate you actually pay. That number should be on every statement for a credit card. For fixed-rate loans, it'll be in the loan agreement.

Comparison

The comparison is straightforward, except for one detail: Time. You only get the corporate match once, but you go on paying interest on your debt until it's paid off. So, you need to include that in your calculation.

If you can pay your debt off in one year, then you can just compare the rates--as long as the interest rate on your debt is less than the corporate match, put enough in the 401(k) to get the full match. If the corporate match is 100%, only the most pernicious of payday loans will have an interest rate so high that paying off debt makes more sense than funding your 401(k). Even a match of 50% is high enough that only seriously predatory loans will deserve to be paid off before funding your 401(k). (This is why so many financial advisors just give the blanket advice to fund your 401(k)--a 100% or even 50% match is so good that it just swamps other considerations.)

If your debt is going to linger for two or three years, though, the calculation begins to change. If you've got some high-rate credit card debt that's costing you 27% a year and that's going to take you two or more years to pay off, then attacking that debt would make more sense than funding a a 401(k) with a 50% match. For a rough calculation, just multiple the interest rate by the number of years it'll take to pay off the debt. That won't be exact (because the amount owed will decline over the period), but it'll be close enough that it's probably not worth going to any trouble to make a more accurate calculation.

If your debt is at 20%, then you're better off funding your 401(k) as long as you'll be still be able to get the debt paid off in 5 years (if you've got a 100% match) or 2.5 years (if you've got a 50% match).

Considerations

There are certain limitations to the calculation. To begin with, you have to be careful about extending this sort of analysis to longer-term, lower-rate debt like mortgages or student loans, for two reasons:

First, once you go beyond a few years, the effect of the declining balance begins to be large--large enough that you can't just use the simple form of the calculation. You can't just say that you should put your money into paying off your 6% mortgage if it's got more than 17 years to run.

Second, the corporate match is only one source of gain for your 401(k) contribution. There's also the interest, dividends, and capital gains that the investments in your 401(k) can be expected to return (the difficult investment climate of the past few months notwithstanding).

Still, for shorter-term debt, the comparison is usually so stark that a rough calculation like this will give you the right answer. If you've got a payday loan where you're paying a 246% APR, there's no question that you're better off suspending your 401(k) contributions until you get it paid off. If you're paying ordinary consumer debt interest rates, you're probably better off going for the match.

A few other details:

Don't forget that you have go on making the minimum payments on each of your debts. (Even a very high corporate match wouldn't leave you ahead if you defaulted.)
Allow for the fact that your 401(k) probably only lets you contribute whole percentages of your salary, and probably only lets you change the contribution level at certain times.
If your 401(k) has a tiered match, you have to do the calculations separately for each tier--it may well make sense to fund the first few percent that get the higher match, but to not fund the next few percent that get a lower match.

These factors don't affect the basic calculation, though.

Emergency fund

With credit card companies piling punitive interest rates on top of already high late fees, it has become especially important that you have an emergency fund. Even if it means a delay in getting your debt paid off--even if it means giving up some sweet, sweet 100% match money--you simply have to have enough of an emergency fund to bridge something like a holiday weekend glitch in the direct deposit of your paycheck. Ideally you'd want a much larger emergency fund, but the rock bottom minimum has to be enough to make one minimum payment on all of your debts. Anything less than that leaves you too vulnerable.

The corporate match on a 401(k)--if you're lucky enough to have one--is often too good of a deal to turn down, even if it means paying off your debts more slowly, or taking longer to accumulate an emergency fund. Under certain circumstances, though--such as a debt with a very high interest rate, or an emergency fund so small that you're exposed to any little cash flow hiccup causing you to miss payments and end up owing more in late fees and higher rates than you'd gained from the match--you need to take care of those items first. Now you know how to figure which situation you're in.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Should You Choose a Roth 401k or a Regular 401k?

Xin Lu — Fri, 23 May 2008 07:46:43 +0000

Yesterday I was talking to a friend and he mentioned that his company just started offering the option of investing in Roth 401ks. He was wondering if he should stick with his regular 401k or switch to the new option and we talked about the pros and cons of each for a little bit. Here are my conclusions.

A Roth 401k or 403b is a relatively new retirement vehicle that allows employees to put away contributions on an after-tax basis. The yearly contribution limit is the same as a regular 401k, but the earnings will be tax free. Tax free earnings are very enticing, but as with any financial decision, the best choice for you really depends on your specific situation. For me, I would still go with a regular 401k, and here is why.

1. I expect my tax rate to be lower in retirement - Right now my husband and I are really in our peak earning years and we have a very high tax rate. We only spend 30% of our gross income so if that holds true in retirement we would not need to withdraw that much from our 401k and our taxes would probably be lower than what it is now.

2. A regular 401k reduces my adjusted gross income - Even though you don't think about your adjusted gross income until you file your taxes, it actually affects other parts of your financial health. For example, the recent tax rebates were given in full to singles with an adjusted gross income of $75000. If you made more money than that your rebate would be reduced. However, if you made $90500 and maxed out a regular 401k, your adjusted gross income would be $75000 and you would still benefit from a full stimulus check.

3. It is harder to max out a Roth 401k - Right now my husband and I regularly contribute 17% to our regular 401k and we still have not totally maxed it out. If we had to contribute the same amount to a Roth 401k our take home checks would be a lot smaller. Psychologically, investing into a Roth 401k is just more painful than filling up a regular 401k because of the tax bite.

Those are my personal reasons for choosing a regular 401k, but there are many good reasons for choosing a Roth 401k.

1. If you expect to pay more taxes in retirement - The Roth 401k may be a good idea if you are not being taxed that much right now. However, I would still prefer a Roth IRA over a Roth 401k in this situation because you have more freedom in choosing your investments in an IRA. If you do not qualify for a Roth IRA for income reasons, the Roth 401k is a good bet if you expect your tax rate to increase.

2. If you expect to make a lot more money in your Roth plan - If you think that your investments in a Roth 401k is vastly superior than your regular 401k and you could make a lot more money, then the Roth 401k is probably a better idea since your gains will not be taxed.

3. If you expect to collect a significant Social Security check - Withdrawals from Roth accounts do not count towards your income in determining whether or not you pay taxes on Social Security. Mark Cussen explains taxable Social Security income here.

4. A Roth 401k can be rolled over to a Roth IRA easily - You are required to withdraw from all 401ks and traditional IRAs on April 1st following the date you turn 70.5 years old. However, if you turned your Roth 401k into a Roth IRA you do not have that requirement so you could let your money grow longer.

Ultimately, I think having both taxable and non-taxable accounts in retirement is a good idea. You could withdraw from the taxable accounts when you know your tax rate will be low, and then you could withdraw from the non-taxable accounts when you have huge expenses. Having that flexibility is useful because you never know if Roth accounts will stay tax free forever. At least with the regular 401k accounts you know your taxes are already deferred. So even though I do not have a Roth 401k, I faithfully contribute to my Roth IRA.

Has your employer started to offer the Roth 401k? What was your choice and why?

Written by Xin Lu and published on Wise Bread. Read more articles from Wise Bread.

Left a job? Do a rollover.

Philip Brewer — Sun, 23 Mar 2008 11:02:48 +0000

I saw this poster on the window of a store-front brokerage firm office near the grocery store. Although the firm in question has an obvious self-interest in getting you to consolidate your investments with them, the underlying message is a good one.

As long as you keep working for your employer, you generally don't have the option to move your 401(k) money. But, with the economy the way it is, there's a steady supply of people with former employers. In most cases, if you leave your employer, you'll want to roll your retirement savings out of your employer's plan and into a "rollover IRA." (A rollover IRA is an ordinary IRA, except that the fund manager keeps track of the fact that the source of the money is from a rollover, which preserves your ability to roll it into a future employer's 401(k), if you want to.)

Reasons to move

There are a lot of reasons to move your 401(k) (or other similar account) when you leave your employer.

Customer service

The biggest is simply that your ex-employer isn't interested in providing a service to you. They may be perfectly happy letting you leave your money in the plan--that spreads the costs of the plan over that many more dollars--but they're not in the business of providing customer service to ex-employees.

They're not really in the business of providing customer service to their current employees either, but they are constantly looking for the cheapest way to keep their employees satisfied enough to hold turnover to a manageable level. Providing adequate customer service for the retirement plan can be more cost effective than, for example, raises--but ex-employees don't fit into the calculation at all.

If you go with a rollover IRA from one of the major fund families, such as Vanguard, Fidelity, or American Century, you'll be getting your customer service from someone whose job it is to provide good service to its customers--and you'll be one of those customers.

Cost

An awful lot of employer-sponsored retirement plans are high-cost affairs. That's simply because the company usually outsources the plan, and usually outsources it to some operator that comes in and does a hard-sell of a turn-key operation. The plan looks slick, sounds like it will appeal to the employees, and the operator promises to take care of everything.

Unfortunately, the company with the slickest presentation is not usually the one with the lowest costs. A certain amount of cost is unavoidable. On top of the ordinary investment expenses and customer service expenses that any fund will have, there are legal compliance issues (and the laws and regulations keep changing). Companies are going to be willing to pay for all that stuff--and willing to pay a little extra, since they're paying with your money.

The major fund families are selling their services to the person who's going to be paying for them, so their incentives to balance cost and service are more aligned with your interests. They have legal compliance issues for IRAs as well, but a major fund family can spread the costs for that over all the IRA accounts they've got.

General principles

I don't know about you, but when an employer lets me go, I figure it shows that they're not too bright. Either they can't tell a good employee from a poor one, or else they're managing their business so poorly that they have to let good employees go along with the poor ones.

Either way, I see it as a mark in the minus column. If they can't run their own business well enough to keep me employed, why should I imagine that they'd do a good job managing my retirement savings?

Reasons to stay

Cost, again

The only good reason to stay with your former employer is if it offers a good selection of low-cost funds. Although many charge way too much money, there are plenty of others that don't. (In fact, some employers pick up the plan expenses as an employee benefit.) It's not so easy to know which yours is. If your plan offers enough information on costs that you can be sure that they're giving you a good deal on plan expenses, then you may want to stay.

Save a step

You may be going to a new employer with a great 401(k) plan. In that case, you may have the option to roll your old 401(k) money directly over to your new employer's plan. In that case, it might make sense to leave your money in the old plan temporarily, rather than roll it over twice.

Legal diversity

There are a bunch of laws protecting various kinds of retirement accounts from creditors. If you lose a lawsuit or suffer some other terrible financial reversal, your retirement funds are protected to some extent. The thing is, these protections are provided piecemeal by the various laws creating the different kinds of plans--so they're all somewhat different. The upshot of that is that in any particular situation, one kind of plan might be less protected than some other kind of plan. Ideally, then, you'd want to have your money spread over a variety of different kinds of plans. (Everybody knows not to put all their eggs into one basket. There may be a tiny bit of extra protection in using more than one kind of basket.)

Move your money

Very few employer-sponsored retirement plans are as good as an IRA from one of the big fund families. There are a few reasons why you might want to keep your retirement savings with your ex-employer, but they're all special situations that don't apply to most people. Unless you've done the research and know that your ex-employer has a great, low-cost plan, you're better off just moving your money.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Six Horrible Financial Products You Should Avoid

Xin Lu — Thu, 21 Feb 2008 23:38:04 +0000

Dealing with financial products can be very confusing and stressful, but there are some products that you should absolutely stay away from for the sake of your financial health. Here are a list of six things I think people should avoid.

1. The 401k debit card - This is a fairly new product that is designed to let people under age 59.5 raid their retirement funds at an ATM. This is a horrible idea because it makes it easy for people to destroy their nest eggs. Early withdrawls carry a 10% penalty plus tax expenses so $10 withdrawn from a 401k becomes $6 to $7. In the past it took at least a few forms to do an early withdraw from a 401k, and it is not worth the effort to fill out a form for every $5. However, a debit card just makes the process of withdrawing small amounts so easy that I could see people spending their entire 401ks without even feeling it. If you want to read more, Jeremy at Generation X Finance had a great article on this topic .

2. Credit cards that charge maintenance fees - There is absolutely no need to get a credit card with a maintenance fee these days. In the past when credit cards was a new product most of them had maintenance fees, but now very few charge them. I am surprised that companies still issue ridiculously bad cards such as this card that charges a $150 yearly fee plus a $6.95 monthly fee.

3. Store specific credit cards - Store specific credit cards are those that can be used only at the store where you signed up. Do not be enticed to sign up for these cards even if the store gives you 30% off on the day you sign up. The reason is that they generally have very high interest rates and could lower your credit score. These are different from a cobranded credit card that can be used anywhere. An example of a cobranded credit card is the Costco Amex Card, which can be used outside of Costco. Cobranded cards generally have better rates and better internal controls than store specific cards.

4. Payment protection insurance - These are insurance policies marketed by credit card companies or mortgage companies that insure you against debt payments if you become ill or lose your job. It sounds good right? The truth is that they are usually quite overpriced, and the policies have so many exclusions that very few benefit. You are probably better off if you took the money you would have paid for this insurance and saved it in an emergency fund. In the UK these insurance policies were investigated for over two years , and the consensus is that these products are highly lucrative for the lenders and rarely benefit the consumer.

5. Payday loans - These are loans given for the amount of your future paychecks, and they carry ridiculously high interest rates disguised as a fixed cost. If you calculate the interest rate it is often hundreds to thousands of percentage points. I think if you really need the money a low interest credit card is usually better than these loans because you can pay a credit card at the next statement date and your rate would be lower. Another horrible product in a similar vein is the tax refund anticipation loan. Linsey has good articles on both payday loans and the new tax refund anticipation loan .

6. Any financial product you do not understand fully - Any financial product could be a potential disaster if you do not understand how it works and how it benefits you. For example, a lot of the current sob stories relating to foreclosures involve borrowers who did not understand how their mortgages worked. All they saw was their initial mortgage payment and did not understand how the payments would adjust. I did not place mortgages specifically as a bad financial product because all the mortgage options I have seen could be used correctly to the benefit of homebuyers. The lesson here is that before you lay your money on the line for any financial product, you must research it and read the fine print. If you do not do your due diligence, a product that is potentially beneficial to others could be a nightmare to you.

Well, that is my list. What are some of your horror stories involving bad financial products? Inquiring minds would like to know!

Written by Xin Lu and published on Wise Bread. Read more articles from Wise Bread.