Beyond Paycheck to Paycheck

at December 11, 2008 in Retirement and Tax. 0 Comments

Year-end obsessive man is here again. Previously, I wrote of the importance of using your FSA funds before losing them, maximizing your match in December and taking tax advantage of any capital losses. Today, is tip # 4 and concerns IRAs.

Don’t wait until April 15, 2009 to make your 2008 IRA contribution.

Certainly, don’t wait until April 15, 2009 to figure out where your 2008 IRA contribution money is coming from.

Whether with finances or a birthday party, when you wait to the last minute, things typically don’t go as well as you had hoped (or as if you had planned). By saving between now and next April in your IRA two good things happen:

You’ll probably increase the total amount you’re able to save because it’s not just the amount you can come up with at the deadline.

You’ll begin to take advantage of tax-deferred growth sooner and for longer.

Don’t wait. Also, remember: if you miss making your entire 2008 IRA contribution by April 15, 2009, you can’t make it up later.

Check out the 2008 and 2009 IRA limits. Disclosure: I wrote it.

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Year-End Financial Planning Tip #3: Oh, those losses on capital (and some obtuse sports jokes)

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at December 9, 2008 in Investing, Retirement and Tax. 0 Comments

Continuing on my year-end theme, I blogged yesterday about using your FSA funds before losing them. Previously, I discussed the importance of maximizing your match in December. Today’s tip, and one of the most commonly discussed, is those capital losses.

You: What are capital losses?

When the DC hockey team plays the Bruins.

You: What?

Forget it. Inside joke.

You: This is a blog.

Yeah, might be the last time I try the inside joke thing. Getting back to it: capital losses occur when you buy an investment and then sell it for less. Such investments could include stocks or mutual funds.

You: Like in my 401(k)?

Although you may very well have investments in your 401(k) that have gone down in value and that you chose to sell at a loss, such losses aren’t the capital losses I am talking about.

You: Why not? That’s what I want to talk about.

Sorry, but this post isn’t about year-end strategies concerning your 401(k) losses. Today, we’re talking about stocks and mutual funds you own outside of your retirement plans.

You: Again, why?

Because selling the stocks and mutual funds you own outside of your retirement plans at a loss can potentially reduce your taxes. Selling the investments held inside a 401(k) or IRA won’t do that.

You: Why?

Who am I talking to today, Bryant Gumbel?

You: No. Bryant who?

Forget it. Since your 401(k) and IRA accounts grow tax-deferred, you don’t pay tax when you sell investments within the plan that have gone up in value (gains). On the other hand, if you sell such investments at a loss, you don’t get to deduct that loss either. (Note: there are very rare exceptions to this rule, but you typically need to nearly liquidate your account, not a good retirement planning strategy.)

Investments you sell within a taxable account lead to either capital gains or capital losses. This year, most people who are selling investments are selling them for less than they originally paid.

You: Thanks for that insight, Mr. Madden.

Touche.

The year-end strategy here is to make sure that if you are sitting on investment losers in your taxable accounts which you are considering selling, to do so prior to December 31. You can deduct your capital losses up to the total of any 2008 capital gains plus up to $3,000 of ordinary income.

You: Ordinary income? My income certainly feels very ordinary.

Ordinary income has a tax definition and includes your salary, bonus, even interest income. So selling an asset triggering a loss of $3,000 or more means, for tax purposes, that you made $3,000 less than you actually di.

You: Works for me.

Just make sure you don’t sell something just for the tax benefits.

You: Right. Can I sell an investment and then buy it right back?

Yes, but if you don’t wait at least 31 days before buying it back, then you can’t deduct any loss.

You: Why not?

Because then it is known as a “wash sale” and the rules say you can’t deduct losses from wash sales.

You: Is that where the phrase “It’s a wash” comes from?

I don’t know.

# # #

How many obtuse sports-related jokes can you identify? Are any of them actually funny?

What about personal finance comments? Ever sell something and then realize that wasn’t such a good idea after all?

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Year-End Financial Planning Tip #1: 401(k) Matching Contributions

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at December 5, 2008 in Retirement. 3 Comments

We could all benefit from year-round attention to our finances. Yet, in a typical year (2008 is not typical) most people only think about their finances from January 2 until the last Monday of a full week in January. In 2009, this is January 19.

You: Where did you get such a crazy statistic?

From this Time magazine article, which quotes a person who has calculated depressing day of the year. (Note: the reporter actually says that the “theory has been discounted by many in the academic community” so take it for what it’s worth.)

Still, many people will find that they have completely abandoned their annual New Year’s resolutions by the third week of January, including many aspirations for improving their financial affairs. So, rather than waiting until January to quit better habits, let’s start now.

You: Start quitting now?

No! Start better habits now.

You: I knew that.

Maybe with some early momentum, we can keep going well into 2009 and beyond. Here is the first of five year-end planning tips:

Tip # 1: Maximize Your 2008 401(k) Match

Did you know that the amount of money any employer will match in a 401(k) is limited?

You: Yes. Plus, many folks don’t have a 401(k) match or even a 401(k) plan.

True enough. But for those who do have a matching plan, December is an important time of year to realize that the match limit is an annual one.

You: I thought the limit was up to a certain percentage of gross pay, like 6%.

That’s true, too. Let’s say you work for a company earning $40,000 per year and your employer matches 50% on the dollar up to 6% of your gross pay. This means that the maximum match you can receive from your employer is $1,200. (This is calculated as 6% (the most they’ll match) multiplied by your $40,000 salary = $2,400. Take the $2,400 and multiply it by the 50% matching percentage for your maximum match of $1,200.)

You: And, in order to get the $1,200 you have to contribute at least $2,400, or 6% of gross pay, to the plan.

Precisely.

You: But how is this related to year-end? This limit true throughout the year, isn’t it?

Indeed. However, that $1,200 limit is an annual limit. If you haven’t received the whole $1,200 yet, you probably have two or three paychecks left in 2008 during which you can try to get as much of it as possible.

You: But to do so, you must contribute more! But that’s true all yearlong!

Yes, but now you don’t have 12 months left. You only have a few weeks. So, instead of raising your 401(k) contribution rate to 6%, raise your contribution level as high as you can possibly afford for just a few weeks- then lower it come January. By doing so, you’ll dramatically increase the amount you have saved for retirement during 2008, maximize the amount of free money you accept and, importantly, avoid permanently forgoing this free money.

You: Permanently forgo?

Once 2009 rolls around, you can never get your 2008 contribution money. Now you’ll have the 2009 limits to contend with. That’s why December matters. And it matters every year.

# # #

What other year-end strategies do you wish to share?

Have you ever temporarily adjusted your 401(k) contribution rate strategically? How did it work out?

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What have you changed?

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at November 10, 2008 in Cash Flow and Retirement. 0 Comments

As I flew across the country yesterday, I sat next to a woman who was heading to Tahiti. She explained to me that this was supposed to be a retirement trip, but with the market’s recent slide, she decided to work another six months. Still, she was going to take the trip because much of it was already paid for. Clearly, I don’t know her entire financial situation, but I thought it was a bit odd.

I mean if you really got hurt badly by the correction, then six months of additional pay probably isn’t going to matter, especially after subtracting the costs of what I can imagine to be a rather expensive vacation to Tahiti (nice lady, but she and her husband spent over $30 on airplane liquor by the time we got to South Dakota).

But the brief exchange did get me to thinking, what have you changed, if anything, since the recent worldwide realization of slower growth, a recession and a market crash? All answers are acceptable, including buying less branded groceries, smaller packets of toilet paper, no change at all, even delaying your retirement for six months!

P.S. I am in Hawaii this week delivering several seminars at the ING DIRECT cafe grand opening there. As a result, I may be a little less active on the blog this week.

Aloha and mahalo!

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Friday Q & A: What should I do with my raise?

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at September 19, 2008 in Gary, Investing, Q & A and Retirement. 4 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I just received a significant raise and now I can afford to save more. I already max out my 401(k) and a friend of mine said that the best thing to do now is to buy an annuity because that way I can get more tax-deferred growth. But my wife’s friend told her a whole life insurance policy would be better since there’s an insurance component. Last, a friend of mine at work says I shouldn’t do either; instead, he says, I should just get index funds. Who’s right?

–Jonathan P., 26, Cincinnati, OH

Congratulations on your raise, Jonathan. It appears that your increased income has made you attractive to a few others already.

Gary: Indeed, I scour the “Movers and Shakers” column every week. When’s the best time to catch you, JP?

While your dilemma may seem confusing, it’s actually not. Let’s address a few points:

Tax-Deferred Growth

While tax-deferred growth is important - especially for long-term saving objectives like retirement - it is far from the only consideration. You must also think about risk, required return, ability to access funds in an emergency, fees/penalties, and so forth. Both annuities and whole life insurance policies do promise the benefit of tax-deferred growth.

Gary: Amen!

However, so does an IRA. With an IRA, you can invest in index funds, which will have very low expenses. So, if you are looking to save more for retirement and have not yet done an IRA, I’d start there. (You should also consider a Roth IRA, which allows the benefit of tax-free growth.)

An annuity is seldom an appropriate product for a 20-something because of the lack of flexibility in the product and the existence of other greater financial priorities typically not yet met by a 20-something (including full funding of 401(k), IRA, emergency fund, etc.). A whole life insurance policy is also not something relevant to a 20-something, especially one without any dependents. Life insurance is arguably the most important financial consideration out there - once you have a child (or, perhaps someone else) depending on your income. But if no one is hurt - financially speaking - by your untimely demise, you don’t need life insurance, and certainly not just to get the tax-deferred benefit.

But before you go ahead and put your money into an index fund, make sure you understand the goals for your money. If it’s for something long-term such as retirement, go ahead. But if you have not yet paid off all your high-interest debt, established an emergency fund, made significant progress towards a housing downpayment (or already own a home), I suggest starting in one of those places before putting more money in the stock market.

And be sure to continue to ask questions first, buying (perhaps) later. You’ll never regret sleeping on a financial decisions. If it’s a great idea today, it will still be a great idea tomorrow.

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Making intelligent 401(k) investment decisions

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at August 20, 2008 in Benefits, Investing and Retirement. 3 Comments

You: Which funds should I pick?

What?

You: In my 401(k) account. . .I have like a dozen funds to choose from. Which ones should I pick?

I can’t give you specific investment advice.

You: Right. I knew that. Well, then, how can I pick the right funds?

There aren’t any “right” funds.

You: Okay, I think you’ve got this financial education blog all wrong. You’re supposed to be helpful.

I’m trying to be.

You: Excuse me for saying so, but I’m not quite seeing it yet today.

Fair point, but I’m just answering exactly the questions you’ve asked.

You: Where’s the issue then?

You said “right” funds. There’s no such thing. If there were, taken to its logical conclusion, there would be no “wrong” funds and then, paradoxically, there would be no funds that were especially “right.”

You: What is this, Waiting for Godot?

Love the 8th grade English reference. Classic. But unlike that play, we’re going to get somewhere today.

You: When, today?

Now.

You: Okay, good.

While there is no “right” fund, there are funds that are more likely to be “right for you.”

You: Why?

Because you have specific investment needs and a specific risk profile. In the case of a 401(k) plan, your specific investment need is (or, at least, should be) to provide for a comfortable retirement. If you’re more than, say, 20 years from retirement, you have a very long-term horizon for retirement.

You: Rubbing it in?

Not at all. Rather, I’m emphasizing that you ought to consider a long-term philosophy when you select your investments. Someone looking that far out (20 years) can afford the normal gyrations of the stock market and therefore should be invested primarily in stocks. For my best guess as to how you should invest your 401(k) account (by asset type, not fund type), visit my unbelievably simple asset allocation tool.

You: Unbelievably simple?

There’s only one question.

You: That’s true of some blue books.

True enough, but the one questions in this case is demographic in nature.

You: Oh.

Yeah.

You: I can do that.

Indeed you can. There are other asset allocation calculators out there which are more robust (google: asset allocators), but I prefer simplicity.

You: Okay, but how do I convert this asset allocation information into fund selections, especially if I don’t know how to pick the “right funds for me.”

Now that’s a good question.

You: Don’t tell me it’s my first one.

It’s definitely not. There was an excellent article a few days ago called “Five Ways to Pick Mutual-Fund Winners” which provides a great summary of what you should consider. Check it out. Not enough time?

You: Maybe.

Here are the top 5 methods, according to writer Jonathan Burton, along with my italicized comments.

1. Expenses - the lower your expenses, the easier the job the fund manager has to do to in order for you to end the year with more money.

2. Risk-adjusted return - Check out the fund’s volatility. In any one year, a manager can get a higher return (as well as a lower one the following year) by taking additional risk.

3. Results vs. peers - Classic apples and oranges analysis. Make sure your gala isn’t next to your naval.

You: That’s what she said.

Wow.

4. Portfolio Yield - Yield is the current rate of income (think dividends) divided by the value of the holdings. (think stock price). The point here is that yield can increase for two reasons: a) because income paid out by the underlying stocks has increased, or b) because the value of the stock holdings has decreased. Only one of those is a “good” reason, so you can’t get too excited about a higher portfolio yield.

5. Manager Tenure - When you’re looking at the records of funds over the last 3, 5, or 10 years, make sure that the current manager has been there at least that long. Otherwise, it’s like saying that Joe Girardi is a great manager because of all the World Series the Yankees have won.

You: Those happened before Girardi become the manager. He just started this year.

Exactly. Irrelevant. He may be a great manager, he might not be, but the evaluation period is mostly in front of him, not behind him.

# # #

What other factors do you consider when selecting a mutual fund from your 401(k) plan?

"financial education"

Friday Q & A: Picking an IRA custodian

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at July 11, 2008 in Q & A and Retirement. 0 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question

Are all custodians of Roth IRAs the same? How do I know whether to pick Ameriprise or Fidelity or a different custodian?

–Jennie K., Burnsville, MN

STRAIGHTFORWARD ANSWER
Although all Roth IRAs are the same, all Roth IRA custodians are not. Choose a custodian the same way you chose a bank.

More detailed explanation:

An Account is Only an Account

First, remember that a Roth IRA is a Roth Individual Retirement Account. An account is just a place to hold money; they’re is nothing unique about it. You can open an account and not even put money in it (Of course, it’s useless to do so, but many people open IRAs intending to put money in and subsequently forget.). The point is that there are lots of places to get an account; no one has cornered the market on IRAs.

Choices For Your Investments

More important is how you’ll invest the money once it’s in the IRA. While retirement plan investing is an entirely different conversation, your investment choices are relevant as you evaluate different custodians. For example, can you purchase no-load mutual funds from the potential custodian? If so, are they any good? Can you buy with no sales commission from many different fund families, or only a limited few that are affiliated with the custodian?

Account Fees

Another top consideration when choosing an IRA custodian are fees. This is particularly tree for young people or people who are just starting to invest for retirement who therefore have low balances. Make sure you aren’t going to get hit with excessive fees. Paying $39 a quarter or something similar because you don’t have (for example) $10,000 or more in your account is very expensive. Critically, it puts an unnecessary additional hurdle in your quest to grow your retirement plan balance over the long term. There’s no reason to pay expensive maintenance fees. To me, anything more than a few bucks a year is ridiculous, especially when there are many no-fee or low-fee IRA programs out there.

Automatic Investment Programs

Another way to reduce the chances you’ll have to pay any fees for simply holding an IRA is to sign-up for an automatic investment program (often abbreviated AIP).

You: What else would they abbreviate it to besides AIP?

Four letters, my friend: R.S.V.P.

You: Gotcha.

Signing up for an AIP means you agree to invest a certain dollar amount (often as low as $50 a month) and, in exchange, the custodian agrees to waive most, if not all, of its account fees.

Inexpensive access to a diverse array of investments, minimal account fees, and programs like AIP are all important considerations when selecting an IRA custodian. It’s not much different than selecting a bank, except, perhaps, that location matters even less. Almost everything these days can be done online; so if the custodian you’re considering isn’t as close as another one, but you like the one that’s a little further, go there. Or to that firm’s web site.

Today

Most important: just get started. Don’t let the uncertainty of choosing the absolute best custodian cause you to delay saving and investing for your retirement for more than an hour. First of all, there is no “perfect” custodian. Second, you’re going to make mistakes. Just make them small and make them early in your financial life. Such minor errors are much easier ones from which to recover and to laugh at years later.

"financial education"

Graduation Speech Part 8: Who is Ira Roth?

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at July 3, 2008 in Graduation Speech and Retirement. 0 Comments

Although I am often asked to speak to recent grads, I have never been asked to speak at any graduations. But if I were, I imagine I would deliver something along the lines of this speech.

Today is part 8. To see the entire speech released so far, click here and read from the bottom up.

Rule 7: Ira Roth is not your congressman

Ira Roth is also not the random guy who knows your name and though you really ought to know his, it’s been like two years since asking him to remind you of his name wouldn’t have incredibly embarrassed both of you.

A Roth IRA is the greatest thing since, well, plastics! Actually, it’s even better because, to the best of my knowledge, profits on plastics were never tax-free. With a Roth IRA, your money can grow and grow and grow, for the next forty years (or more), without you ever having to pay taxes on the account. New grads earning at least $5,000 this year can contribute up to that amount in a Roth IRA. Do so. This year. No one ever gets into trouble during retirement because they saved too much when they were younger.

At this point, I’m guessing that you wish I would simply turn the conversation back to sex. You’re thinking: “Sitting down with my parents to have ‘the talk’ was so uncomfortable” or “Man, I totally remember Kenny! That guy was crazy!” But the sex part of today’s talk is over. Sorry about that.

You’ve perhaps debated whether size matters or if performance counts. Well, of course, it turns out the same thing is true with sex. I hear rumbling – were you already thinking I was referring to sex again? You people! This is a money talk. No, we’re not going to talk about Eliot Spitzer either!

[To be continued]

"financial education"

Retire Debt-Free: Friday Q & A

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at June 6, 2008 in Debt management, General Financial Planning, Investing, Q & A and Retirement. 1 Comment

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question

Do I need to have all my debt paid off prior to retirement?
–Mick V., Uniondale N

STRAIGHTFORWARD ANSWER
Not necessarily, especially when it comes to your mortgage. And paying off credit cards prior to retirement is critical, it certainly won’t hurt to have your mortgage paid off too.

More detailed explanation:

Credit Cards

Well, there aren’t too many happy retirees carrying around high credit card balances. Truth is, a comfortable retirement and large credit card balances don’t often go together. High credit card balances alone can sabotage an otherwise completely sound retirement plan.

After all, if you can’t pay off your credit card bills while you’re working, how could you possibly expect to pay them off when you’re no longer receiving a paycheck?

Mortgage

Having the mortgage paid off before you retire is a huge confidence builder to retirement. It’s one of your biggest bills your whole life and now you’re living rent-free for the first time since you were a teenager.

Having it paid off a great goal. Plus the tax advantages of a mortgage decrease as you get older, since you’ll likely have less income and will benefit from a higher standard deduction, it’s probable that less of your interest payment will result in any tax benefit.

Also, keep in mind the following: A house isn’t a substitute for a retirement plan. Many people have recently learned that the hard way now that we are in a down housing market. But even in an up-market, which we will one day have again, it’s unrealistic to think that you will be able to cash-out of your house and fund a sizable part of your retirement. Once you get used to a certain home price, it’s hard to step too far down. Even if you downsize in size, you’ll typically upsize in location or quality and not take out as much money as you might plan on.

Don’t over-rely on your house. There are plenty of other retirement savings opportunities (your 401(k), your IRAs, etc.). Take advantage!

"financial education"

A credit (not just a deduction!) for retirement saving: Friday Q & A

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at May 30, 2008 in Q & A, Retirement and Tax. 0 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I saw something on the news yesterday about a credit for saving for retirement. I thought you could only get a deduction for an IRA or 401(k) contribution. How do I take maximum advantage of the tax law when saving for retirement?

–John B., El Segundo, California

STRAIGHTFORWARD ANSWER:

If you qualify, the credit for retirement plan contributions is a huge opportunity.

More detailed explanation:

First, a review of the differences between a tax deduction and a tax credit: When an expense is deductible, the item reduces your taxable income. Let’s say you have a $1,000 expense related to your move from one state to another. Since moving expenses related to a move like this are typically tax deductible, your taxable income is reduced by $1,000. If you are in the 25% tax bracket, this means your taxes will decrease by $250 (25% x $1,000).

A tax credit of $1,000, however, works differently. Let’s say you recently had a child (like me!) and as such qualified for the child tax credit of $1,000. In this case, your taxable income is unaffected by the credit (no deduction), but your tax will decrease by $1,000.

In short, a tax deduction is worth the amount of the expense multiplied by your tax rate, while a credit is worth the full amount of the stated credit. As a result, credits are usually much better.

Still, many credits are non-refundable.

You: Like advance-purchase airline reservations?

Sort of. Actually, not really. A non-refundable credit is one where the amount of the credit is limited to the amount of tax you would have otherwise had to pay. So if your tax liability would have been $700, the value of a $1,000 non-refundable credit is limited to $700. (What this really means is that you can’t get a refund of taxes you haven’t paid as a result of a non-refundable credit).

Now let’s talk about the credit for retirement savings contributions. This is a non-refundable credit for up to $2,000 for those making retirement saving contributions (to either 401(k)s or IRA’s). During 2008, if you are single and make less than $26,000 you’ll probably qualify for this credit. If you are married and filing jointly, then you can make up to $52,000 combined and still receive the credit. The lower your income and the more you save for retirement, the higher the credit.

You: What about the deduction?

You get that too!

You: So I’d get a deduction and a credit for the same savings?

Indeed. Of course, your income must be below the limits above, but if so, do your best to save something for retirement. Retirement savings made by those eligible for the credit cost the saver next to nothing.

Note that you must be at least 18 and not claimed as a dependent on your parent’s income tax return to qualify for the credit.

Hey, you graduating college seniors, this might be you! Think about it, you’ll be earning just a half-year’s salary this year. What a better way to start saving for retirement than doing so while you are still young and with minimal net-impact to your cash-flow. That’s what I call living Beyond Paycheck to Paycheck.