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401(k) – 5 Deadly Traps You Need To Avoid When You Love Your Money

Financial Ginger - 401(k) traps

By Guest Author: Stacy Miller

Financial experts keep talking about 401(k) and how it’s beneficial for us. But do you know what it actually is? Well, Investopedia defines a 401(k) account, “A 401(k) plan is a qualified employer-established plan to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan accrue on a tax-deferred basis.”

If a 401(k) account is used properly, then you can save a lot of money for the golden years of your life. However, there are a few traps or pre-retirement blunders you need to avoid when you’re participating in a 401(k) plan.

Trap #1. Using a 401(k) account as your credit card: Please understand one thing that a 401(k) account is not your credit card. It is a tool that can help you boost your retirement savings. But if you take out a loan from your 401(k) account, then it will be a terrible mistake. Here are a few reasons:
a) The outstanding balance will be due within 2 months of separating from your employer.
b) You have to pay origination fees and maintenance fees. These are extra costs.
c) You have to pay penalties in the event of loan default. Plus, the loan will be considered as a taxable income. (You’re going to be paying taxes, on your own money twice)

Trap #2. Assuming that 401(k) and Roth 401(k) are same: Both are distinctly different from each other.

According to Bankrate, a Roth 401(k) account is, “An employer-sponsored retirement plan that lets employees have the option of setting aside money from their paychecks that’s taxed upfront and saving it in a retirement account where it can grow tax-free forever. Money can be withdrawn tax- and penalty-free as long as the participant is age 59½ and has held the account for at least five years.”.
The key differences are:

401(k) – Contributions aren’t taxable for the year you’re making contributions (dont pay taxes now, pay them when you withdraw at retirement)

Roth 401(k) – Contributions are taxable for the year you’re making contributions (pay taxes now and not later when you withdraw during retirement)

401(k) – This is subjected to RMD by the day you turn 70.5 years old.

Roth 401(k) – This isn’t subjected to RMD by the day you turn 70.5 years old.

Let me define RMD for those who don’t have any idea about what a Required Minimum Distribution is: “A required minimum distribution (RMD) is the amount that traditional, SEP
or SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts by April 1 following the year they reach age 70.5.”

It is important to know the rules and do all the calculations correctly. Otherwise, you’ll be in a mess.

Problem #3. Not reviewing/updating your contribution percentage annually: You have to select a percentage that will be taken away from your wage and put into your 401(k) retirement savings plan. It has been observed that plan holders often forget about this contribution percentage, which is a big mistake.

Your financial health changes when your life scenario changes. For instance, you get married, you have your first baby or you get a big salary hike. If you analyze carefully, you may find that your contribution amount is either too big or too small. Though it isn’t investment advice and FinancialGinger cannot be responsible for the actions of readers based on its opinion, FinancialGinger generally recommends to at a minimum contribute the maximum match offered through your companies 401(k) program.

Problem #4. Not taking advantage of maximum employer match: You’ll lose a hefty amount if you miss out on maximum employer match. In a survey of 360 employers, it has been observed that 42% of them matched employee contribution. 56% of these employees only required workers to contribute 6% from their wage to qualify for the maximum employer match. It is said that the average missed employer contribution amount is $1336 every year.

Huge Issue #5. Not adjusting your portfolio at regular intervals: You need to rebalance your portfolio at the time of choosing index funds. It might be the case that you’re holding 90% in a low-cost index fund and 10% in government bonds. However, as the market condition changes, you need to adjust your portfolio allocation (What % of your money is in each asset class) as well.

If the S&P 500 has a huge rally (quick jump upward), it will be risky to hold 95% of your 401(k) in the index fund.

Action Items

1. Never take out a loan from your 401(k) account unless you have no other option. Analyze all your loan options and compare them with your 401(k) account. Know about the tax and penalties.

2. Review your percentage contribution whenever you experience major life events (marriage, a new job, or a pay increase). It is best to review it at least every year since your financial situation doesn’t remain the same all the time. Always opt for an annual increase option if your company has one. Annual increase options automatically keep your percentage match the same even if you get a pay increase.

3 (The most important action item). Once you’re eligible for maximum employer match, make sure you take full advantage of it. Make the required contribution to maximize your employer match.

4. There is no need to roll over your money from 401(k) account into an IRA at the time of switching jobs or retirement. It isn’t compulsory. If you’re satisfied with your current plan, then keep your money there. Also, many companies allow you to roll your 401(k) account from a previous job to the new job. Be aware of your options.

Comment from FinancialGinger: My Dad kept old 401(k) accounts from jobs worked 20 years ago. That may be good, or may be bad in your situation. Ask a Professional for guidance in investing. (Or wait until I pass my exams in Spring of 2018 and I can be your professional guidance!)

5. Several 401(k) plans have automatic annual rebalancing feature. Read the terms and conditions of this feature minutely to determine if it’s good for you. In case your plan doesn’t have an automatic rebalancing feature, you can select a date to adjust your portfolio every year. Many financial companies and ETF’s will rebalance at least once a quarter, this may not be best for you, but at a minimum, most professionals recommend at least annual rebalancing.

Conclusion
Depending on the rules, you may qualify to enroll in the 401(k) plan within 1-12 months. If you’re eligible to contribute from December, then don’t wait till the next year to establish your retirement account since (a) you can lower your taxable income for the current financial year by contributing your pretax dollars (b) your employer can contribute next year but make it count for the existing year. When you start a new job, try to set up your 401(k) account by December 31st if by all possible.

 

About the Author: Stacy B Miller is the content editor at Oak View Law Group. Her articles revolve around topics related to debt, credit, laws, money, personal finance, etc. You can connect with her on Twitter

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The Basic Financial Plan

Basic Plan

A frequent question that people ask their one financial friend all the time is, “What should I expect when…” and the next bit is usually the part about getting a new job, or paying for a house, or what a good interest rate looks like for a car. Sometimes these questions are about saving for retirement, what a realistic return is for their 401(k), and how they should prepare to retire. Occasionally the question is “why is it important that…” or “Do I really need…” of course the answer is usually yes.

“Yes if you save younger it’ll make it so you can retire easier”, “Yes, Life Insurance is beneficial for most people who have dependents or debt like a mortgage”. The fact that you’re asking, is a sign you have a general idea of what you should be doing.

I figured I’d try to compile a bunch of basic principles that will get any individual to retirement in a relatively save and aware way. The purpose here is to help you set your expectations of what you need to do and understand in order to have enough money to one day be able to say, “You know what? I don’t need a job anymore, and I can live the rest of my life off of my own money.”

 

There are three basic parts of our financial life: Saving, Investing, and Diversifying.

First: Saving

Everyone hears a ton about saving, so I’m not going to hash why you should save any more. Just a few stats. The average person that should retire, (I.e. is 65+ years of age), only has about $80,000 according to Dr. Craig Israeleson of UVU. The Motley Fool recently found numbers could be potentially as high as $148,000 for those between 65 and 75.

Why does that matter to you as a 20-30 year-old? Here’s why, those people that can’t retire, they are holding your jobs. Once they retire, everyone down the line can start moving up.

The amount you save will directly relate to how much money you have for retirement. Many experts recommend saving 10% of your income, Dr. Craig Israelson, who performs research and analysis on portfolio theory, and investment returns suggested in a lecture at UVU that many millennials should adopt a rate of 15% of savings for retirement. Once you graduate and get that first job, immediately start saving 15% of every dollar you earn for retirement, and according to the experts, you’ll be very much secure for retirement.

Second: Investing

Being a Millionaire has nothing to do with income, but everything to do with Net Worth. Think about how time affects the value of money. Its been exhaustively said, so you can just google it, but the difference between the same $5,000 invested at the age of 25 and invested at 50 when you’re 65 is dramatic and exponential.

Consider a Crockpot. Have you ever gone to church on a beautiful Sunday morning, come back in the afternoon, and decided, “I want a nice roast and potatoes for dinner” then set the crock pot at 5pm for dinner at 6?

If you have, you should seriously reconsider your dining experiences. Waiting until “Later” to save if you’re not in school, is the same as setting the crock pot a-cookin’ after church, instead of the morning of, so it can simmer and soak in goodness all day.

Investing: I’m sold, but WHERE?

This is where everyone says, “Jacob, you’ve sold me on this. Where do I put my money?”

Betterment is an amazing place to invest your money. Acorns isn’t half bad either. Wealthfront is a newer online investment site that utilizes algorithms, often called a robo-advisor(LINK TO 7 TYPES OF INVESTMENT ADVISORS), and your risk to make your money grow too, and its free for portfolios smaller than $15,000. It’s also not hard to go directly through a major company like Schwab, Fidelity, or VanGuard.

Part of your portfolio (your money for retirement), will be in your 401(k) at work. You’d better be matching that sucker to 100% of the matching contribution, because if not, that’s free money you’re missing out on. Make sure the limit of up to $5,500 a year beyond your 401(k) is going into an IRA with whatever advisor you’re using, because that can create some tax savings. Then, any above that can go into either a personal brokerage account through your investing institution or other more complex retirement accounts you can work with a professional on. (The secret is to get started).

Third: Diversify

Here is where I’m going to teach you some amazing truths about investing. If you’re invested in 10 different things and they are all going up by exactly 6% a year. There is some serious issues. That means all of your investments are perfectly correlated, which means if they drop one year by 40% (cough 2008) then they are all dropping. A good portfolio has uncorrelated assets. Meaning that at least part of the time, when one is going up, another will be going down. Some parts of the global economy will be having rough weeks or days or years, while others have awesome times, then 5 years down the road it’ll switch. Because the market is unpredictable, meaning that it’s impossible to know exactly what will happen, a diversified portfolio that has a little bit of money in all types of markets is proven to generally outperform any one specific investment type.

Three Analogies: Baseball, Salsa, and Cereal

Imagine that stocks are like baseball players. If one stock bats at .365 and another bats at .127 but only hits home runs, you want a little bit on both players! According to portfolio theory, the more batters you have, the higher your average becomes, while reducing variance. Stocks bat at about .700 and bonds bat at about .960. Enough to be in the hall of fame for any baseball player in the history of ever.

So, what does this mean? It means you should put money in stocks, put some in bonds, put some in Mutual Funds that use active aggressive algorithms and research to try to find opportune moments to buy and sell stocks to make you money, use some passive ETFS that just automatically balance 50 or 100 stocks in a particular category like large healthcare companies, or medium growth companies that pay dividends.

Imagine this investing like making Salsa. If you invest in the S&P 500, sure, you have some diversity, but you just purchased 500 different types of tomatoes. Of course, you can’t invest in the S&P500 but you can invest in ETFs and mutual funds that invest in it. So, if you invest in some large cap stocks for your tomatoes, then you buy some bonds for your onions, purchase some commodities for your cilantro, and so on and so forth, you’re going to be making a good salsa.

In fact, experts have shown that the recipe (allocation) of your salsa (investments) accounts for 94% of the deliciousness (returns) in them. Meanwhile, the ingredients (actual funds and investments) only account for less than 6% of the taste (return). Using a great recipe for salsa makes better salsa then just getting good ingredients, but having an awful recipe. If you have perfect ingredients, but the wrong recipe? You’re not even making salsa any more.

Many people have told me, “I’m invested in a mutual fund, I’m diversified”, or “I’m invested in an ETF” or “Target-date Fund”. Well, yes, this is diversity, but it’s the 200 types of tomatoes diversity. Think about Cereal boxes. Do you remember those funny boxes that had 8 miniature boxes inside of them? This is how you should think about a mutual fund. Each box of cereal is a specific investment, the Mutual Fund, or ETF, or Target Date Fund, is the whole package. It choose those 8 investments and said, “here’s a good deal”. If you choose a Mutual Fund for 12 different asset classes: Large Stock, Small Stock, Mid stock, non-us stock, emerging markets, real estate, resources, commodities, US bonds, TIPS, non-US bonds, and Cash, you’d have a pretty awesome set of cereals.

You will have created a beautiful portfolio, a fund of funds of funds. That is a recipe for success, that now only needs your savings added.

 

Remember your basic financial plan.

  • Save (now)
  • Invest (all of it above emergency funds and short term purchase plans)
  • Diversify (so 2008 doesn’t get you)
  • Retire (at 45, okay maybe not, but still retire)

You’ll thank yourself later (about the retiring side of it, and the stressful side of it, and the peaceful side of it)

 

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Why you should NEVER buy an RV in retirement

“When I retire, I’m gonna buy an RV and travel the country”.

This may be great and all, but the year you turn 65 (or retire, pardon if I offend those who retire at 45 or 70) $60-80 thousand dollars could be a bit much.

I’m going to show you why buying an RV in retirement is a poor choice for most people.

Let Me Explain

Most motor homes people purchase cost somewhere between $50,000 and $300,000. This cost can be significant especially to the future value of your money. This graph is an example.

This is using a low-end camper probably used at about $60,000 dollars. ( https://www.rvtrader.com/dealers/American-River-RV—Sacramento-3018028/listing/2017-Coachmen-Freelander-26RS-119765660 ) over 30 years of retirement, that money can become quite substantial.

Now, Let’s consider vacations. Using “Get Away Guru’s” and other exciting promotionals. It’s not hard to find vacations. If you could budget $10-15,000 in travel a year during retirement that would be great! Maybe your goals are higher, but here’s the deal. In retirement you can travel a lot easier and on a moment’s notice. If you suddenly leave for 2 weeks in the middle of January to the southern hemisphere for warmer weather on a jungle safari, or to travel New Zealand, it won’t be as big of an issue as a family with kids going to school.

The mobility of being retired makes it easier to find travel opportunities at discounted prices.

Figure out what you want to do with retirement. Are you going to do several week-end trips, or do you want to do a 2-week expedition every year? How about several 4 day weekends at national parks around the country? There are so many options. Remember to consider that most people in retirement have a little bit less energy than a 30-year-old.

This is only assuming $80,000 of an investment in an RV type home. If you’re dropping $200,000 on an RV the numbers will only be bigger. With $200,000 the income at 6% being $12,000 a year.

How much vacation and travel can you get out of $5000 a year?

Remember, owning an RV doesn’t mean costs are gone, that’s just the cost of buying it. You’re still spending other money from retirement on gas, maintenance, RV parking, licencing, registration, and more.

Here are three articles that give some awesome consideration to costs, and lifestyle of owning an RV.

Consider the Costs of an RV- https://www.budgetsimple.com/blog/rvs-timeshares-and-vacation-homes-a-good-idea/

More thoughts on the expenses behind an RV – http://livingstingy.blogspot.com/2011/05/future-of-rving.html

Is an RV lifestyle right for you? – http://wheelingit.us/2012/10/17/the-darker-side-of-fulltime-rving-5-thoughts-to-ponder-before-making-the-leap/

My advice is If you are going to buy an RV in retirement to take trips in multiple times a year, save the money instead and use it on hotels and airfare. The bang for your buck is much stronger there, plus you aren’t putting your limited retirement savings into one of the fastest depreciating things you can. AAANND lets be honest, if you want to take an RV out for a couple of days, go rent one for one of those trips.

Ultimately it comes down to this: Keep it invested, the investment return is your play money in retirement.

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5 Ways to Take Dividends From Your Life Insurance Policy

Everyone at some point gets a Life Insurance policy. Why? Because if you die and you’re a parent, what is going to take care of your kids? If you have a spouse, what will keep your spouse running?

But I’m not here to argue whether you should or shouldn’t have life insurance.

I’m also not hear to deep dive insurance or explain the process of buying insurance.

This is about what you do when they ask you “How would you like to take your dividends?” My what? Aren’t dividends a stock thing? (Some maybe even asked, “What’s a dividend”?) To be brief: Dividends are the little extra bits a company pays to you for owning their stock. Some companies don’t give dividends because they reinvest earnings. Many life insurance policies pay dividends in some form, any policy that either invests in the market directly, or allows you to control the investments in the market will yield dividends.

There are 5 ways you can receive dividend payments. Here’s the simple way to remember: CRAPO

Cash

Reduces your basis and is not taxable. Basis is how much money you’ve put into the investment. If you’ve invested $2000 in a stock, and then sell it for $3000 later. You made $1000 dollars. Your basis is that $2000 you put in. With this option you’re reducing your basis by the amount paid out. This also has no tax consequences immediately.

Reduction of Premiums

This is just reducing your premiums. Premiums are how much you pay for your insurance contract. So, you can use the dividend money to make your expense a little less.

Accumulate Interest

With this option you basically keep the dividends invested. The insurance company keeps this money in the same account, but tracks its earning separately. The reason for this is that it’s taxable in the future. The rest of your invested money is still in that tax advantaged insurance.

Paid-Up Additions

Think of Paid-Up as “Paid-In-Full”. You utilize the dividends to add a tiny little bit of permanent insurance to your policy that you no longer pay premiums for. A lot of life insurances have options where you can convert your entire policy over to a permanent paid-up insurance. Of course, this reduces the amount of coverage, or money you get at death, due to the fact that you’re no longer paying into it.

One Year Term

Term insurance is a lot cheaper than Paid-Up insurance. This is when you use the dividends to buy term insurance that lasts one year then expires. The reason someone may do this is because they decide Paid-Up doesn’t add very much. If you look into the cost of permanent insurance compared to term insurance, you’ll see really quickly that term insurance pay-outs can be huge compared permanent insurance. The other real difference though, is term insurance expires. So, if you don’t pass away during the time, then it expires.

Most people usually go with Paid-Up additions, but depending on your situation you may choose another.

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7 Types of Financial Companies

There are 7 basic types of firms that provide financial assistance, support, guidance, education, investments, and solutions/products.

There are Registered Investment Advisors (RIA), Broker Dealers (B/D), Insurance Companies, Robo Advisors, Accounting firms, Tech Companies, and Discount Broker Dealers.

First we have our Registered Investment Advisors. These are, as a general rule, partnerships or smaller corporations that manage the overall financial situation of clients, and in some cases institutional investors as well. They must be registered with the Securities and Exchange Commission (SEC) for each individual state that they have clients in.  An RIA Financial Advisor will conduct information gathering, Risk tolerance, and spend time getting to know your goals and needs. Most of the time they also educate a client as to what the implications are of making different financial decisions. One of my favorite things about an RIA, is that many of them will be full service. They’ll help with investments, real estate, insurance, estate planning, power of attorneys, wills, and more. They may outsource part of it, or bring in an expert to do estate planning, etc. But they keep you aware of the broad scope of protecting, growing, and sheltering your money. You may not have heard of any of these, but here are some RIA’s: Geneva Advisors, HighTower Advisors, Mill Creek Capital Advisors, Ferguson Wellman Capital Management, Swan Global Investments, and True North Advisors.

Broker/ Dealers are those companies that are like The Wolf of Wall Street. I mean, except that fact that they aren’t awful money laundering devils. They call people to sell them financial products, usually in the form of stocks or bonds. Investment advice is given, and they range from small boutique firms to large commercial companies and investment banks. The difference between an RIA and a Broker/Dealer is a B/D historically purchases their own securities (stocks and bonds and other products) and then sells them to the customer, whereas an RIA buys securities on the client’s behalf. The Broker of a B/D is buying and selling on behalf of clients, the Dealer side is when the company trades their own securities. Examples of Broker/Dealers include Raymond James, Wells Fargo, AXA, Waddell & Reed, Voya, and Edward Jones

Insurance Companies usually deal with just that… Insurance! Northwestern Mutual, Geico, Allstate, State Farm, Progressive, Farmers, Liberty Mutual, and New York Life are a few examples. Most of the ones that have huge TV ads. There isn’t much else to say. These companies are very important, and having specialized skills in specific insurances can be very beneficial in reducing premiums and having quicker turnaround times when claims are made. Some RIA’s and B/D’s will have specific individuals/teams in their group that specialize in either selling insurance, or working with insurance companies to get your insurance. One thing I like is how an RIA can work with many insurance companies, whereas an agent for a specific company only sells that Insurance. Some insurance agents will be licensed with several companies and can sell you policies from different companies depending on your needs.

The way of the future is Robo-Advisors. The basic concept here is that you can break down risk tolerance and needs into numbers, and computers can then spit out information about what you should do, or you can authorize a computer to auto-invest and rebalance and work out your investments for you based on your information you give it. Very smart people back these up and as a result of mass users for one program it can be cheaper to use a Robo. Remember though, that holes are usually left, and Robo’s can only do so much.

Tech companies are companies that leverage tech with finance. Lending Club is an example of that. You add money that is utilized in creating loans that then pay you back as the person pays back lending club. Robinhood is a financial app that has free stock trades. Stripe is a payment taking company. Some finance companies create platforms for making trades like TDAmeritrade or TradeKing, (though some may be better classified as Robo-Advisors, depending on how they are used). Some create plateforms for financial planning, like MoneyGuidePro, or SilverTree, that allow you to maintain and track financial data and policies for insurance and estate documents all in one location. One company local to Utah is TradeWarrior, which can auto rebalance any portfolio while taking specific needs and illiquid assets into account.

Accounting Firms are our next stop. These are a finance tracking type of company for businesses and self-employed individuals. They may provide book keeping for paying employees, create budgets and financial statements for companies, and also deal with tax-returns. I suppose they are for everyone in the sense of tax-returns, many individuals go to accounting-firms for taxes, though some companies will specifically only do taxes. Beyond the actual tax returns, accounting firms can help consult on risk management and tax implications of certain operations.

The last of the seven is Discount Broker/Dealers. These are just really really low-cost Broker/Dealers. Think Fidelity, and Vanguard. Vanguard is the most notorious of all of these, as the regularly create huge market changes. Some of their funds will have expense ratios of 8 Bips, which to be simple is nearly three times cheaper than most funds to invest in.

Which ones you’ll want to work with depend on your needs, interests, comfort, and knowledge surrounding the individual companies. Many people want to lump all companies in one category as ‘good’ or ‘bad’ or ‘lazy’ or ‘smart’, but the truth is, there are losers and winners all around. You just have to find someone who is trust worthy, and has a good track record of helping people achieve their goals.