MONEY

Hate Your Company’s 401(k)? Here’s How to Squeeze the Most From Any Plan

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Tooga Productions—Getty Images

Four steps to getting your savings plan right—even if your employer didn't.

Your 401(k) plan is potentially one the best tools you have to save for retirement. You get a tax advantage and often a partial match from your employer. But let’s face it: Not all company plans have the most compelling investment options. These strategies will help you use your plan to maximum advantage.

Money

1. Plug the biggest hole in your account: Costs.

Mutual fund charges look small, but the cost of paying an extra 1% a year in fees is that you give up 33% of your potential wealth over the course of 40 years. If there’s at least a basic S&P 500 or total stock market index fund in your plan, that’s often your best option for your equity allocation. Some charge as little as 0.1%, vs. 1% or more for actively managed funds.

2. Look beyond the company plan.

If your 401(k) doesn’t offer other low-cost investment options, diversify elsewhere. First, save enough in the 401(k) to get the company match. Then fund an IRA, which offers similar tax advantage. You can then choose your own funds, including bond funds and foreign stock funds, to complement what’s in your workplace plan.

3. While you’re at it, dump company stock.

About $1 out of every $7 in 401(k)s is invested in employer shares. But your income is already tied to that company. Your retirement shouldn’t be too.

4. Share strategy with your spouse.

It’s a good idea no matter how much you like your plan: If you hold a third of your 401(k) in bonds, for example, your combined mix may be riskier than you think if your spouse is 100% in stocks. But coordinating also improves your options. If your spouse’s plan has a better foreign fund, you can focus your joint international allocation there.

Adapted from “101 Ways to Build Wealth,” by Daniel Bortz, Kara Brandeisky, Paul J. Lim, and Taylor Tepper, which originally appeared in the May 2015 issue of MONEY magazine.

Read next: What You Can Learn From 401(k) Millionaires in the Making

MONEY Careers

A Good Reason to Tap Your Roth IRA Early

Concentrating surgeons performing operation in operating room
Alamy

You shouldn't always wait until you retire to pull money from your retirement account.

The Roth IRA is a great tool for retirement savings. But here’s something not as well-known: It’s great for developing your career as well.

Many of my young clients in their 20s and 30s struggle to balance current spending, saving for the next 10 years, and stowing away money for retirement. With so many life changes to deal with (weddings, home purchases, children, new jobs), their financial environment is anything but stable. And their retirement will look completely different than it does for today’s retirees.

To my clients, separating themselves from their current cash flow for the next 30 years feels like sentencing their innocent income to a long prison term.

They ask, “Why should we save our hard-earned money for retirement when we have no idea what our financial circumstances will be in 15 years, never mind 30? What if we want to go back to school or pay for additional training to improve our careers? We might also decide to start a business. How can we plan for these potential life changes and still be responsible about our future?”

The answers to those questions are simple. Start investing in a Roth IRA — the earlier you do it, the better.

There is a stigma that says anyone who touches retirement money before retirement is making a mistake, but this is what we call blanket advice: Although it’s safe and may be correct for many people, each situation is different.

The Roth IRA has very unique features that allow it to be used as a flexible tool for specific life stages.

Unlike contributions to a traditional IRA, which are locked up except for certain circumstances, money that you add to a Roth IRA can be removed at any time. Yes, it’s true. The contributions themselves can be taken out of the account and used for anything at all at any time in your life with no penalty. And, like the traditional IRA, you can also take a distribution of the earnings in the account without penalty for certain reasons, one of which is paying for higher education for you or a family member. (Some fine print: You’ll pay a penalty on withdrawing a contribution that was a rollover from a traditional IRA within the past five years. And you’ll have to pay ordinary income taxes on an early Roth IRA withdrawal for higher education.)

Although you shouldn’t pull money from your retirement account for just any reason, sometimes it’s a smart move.

Let’s say you graduate from college and choose a job based on your major. This first job is great and helps you get your feet wet in the professional world. You’re able to gain some valuable real-world experience and support yourself while you enjoy life after school. And this works for a while…until one day, 10 or 15 years into this career, you wake up and begin to question your choices.

You wonder if this career trajectory is truly putting you where you want to be in life. You think about changing careers or starting a business, but you need your income and have no real savings outside of your retirement accounts.

Now, let’s also say that you were tipped off to the magic of a Roth IRA while you were in college and you contributed to the account each year for the past 15 years. You have $75,000 sitting in the account, $66,000 of which are your yearly contributions from 2000 through 2014. It’s for retirement, though, so you can’t touch it, right? Well, this may be the perfect time to do so.

I recently spoke to a someone who did just this. Actually, his wife did it, but he was part of the decisionmaking process.

The wife has been working for years as a massage therapist for the husband’s company. Things were going quite well, but she had other ideas for her future. She wanted to go back to school to get her degree as a Certified Registered Nurse Anesthetist. The challenge was that this education was going to cost $30,000, and they did not have that kind of money saved.

So, they brainstormed the various options, one being to tap into his Roth IRA money. They determined that this would be a good investment for their future. Once the wife became a CRNA, her annual earnings would rise an estimated $20,000 — money they could easily use to recoup the Roth IRA withdrawal (though the 2015 Roth IRA contribution limit is $5,500 for those under 50 years old).

This decision gave them a sense of freedom. The flexibility of the Roth allowed them to choose an unconventional funding option for their future and gave the couple a new level of satisfaction in their lives.

And, that’s what it’s all about. We have one life to live, and it’s our responsibility to make decisions that will help us live happily today, while still maintaining responsibility for tomorrow.

Whether your savings is in a bank account or a retirement account, it’s your money. Although many advisers will tell you otherwise, you need to make decisions based on what is best for you at various stages of your life. The one-size-fits-all rule just doesn’t work when it come to financial planning. There is no need to rule out a possible solution because society says it’s a mistake.

———-

Eric Roberge, CFP, is the founder of Beyond Your Hammock, where he works virtually with professionals in their 20s and 30s, helping them use money as a tool to live a life they love. Through personalized coaching, Eric helps clients organize their finances, set goals, and invest for the future.

MONEY Taxes

The Procrastinator’s Guide to Finishing Your Taxes

flicking wads of paper to procrastinate
Daniel Grizelj—Getty Images Just because I'm not typing doesn't mean I'm not working on my taxes.

The deadline to file your 2014 income tax return is hours away. If you're not done, you're not alone. And you have plenty of options.

I’ll admit it. I’m an editor at a personal finance magazine and website, it’s April 14, and I haven’t yet finished my 2014 tax return. I’m usually a March filer, but, hey, life got in the way this year.

As of 10 days ago, the IRS had received 99 million tax returns, about two-thirds of what the agency expects. So there are tens of millions of us scrambling to reach the finish line. Here’s what you can do if you, too, have put off doing your taxes.

You can file for an extension. It’s a super short and simple form (4868), you can file it online through IRS Free File, and you get another six months to finish just by asking. See you on October 15, Mr. Tax Man!

The rub is that you have to estimate what you owe and send that in, which may feel like as much work as filling out a tax return. “If you’re not 100% certain of the balance due, be conservative and round up,” says Melissa Labant, director of tax advocacy for the American Institute of CPAs. If it turns out you overpaid, you’ll get a refund later or you can apply the excess to next year’s tax bill.

One more thing: Don’t forget to see if your state requires a separate application for an extension.

Reach out to the IRS if you don’t have the cash. When you can’t pay your tax bill in full, you’re looking at penalties and interest. “If you come up with your number by Wednesday but are short the money in your checking account, you have options,” says Mark Luscombe, principal federal tax analyst for Wolters Kluwer Tax & Accounting US.

As long as you owe $50,000 or less, you can apply for an online payment agreement from the IRS, which lets you spread out the bill over 120 days. Another option: Put the bill on your credit card—the roughly 2% fees might be less than the interest and penalties you’d otherwise face.

April 15 is still your last best chance to cut your tax bill. Other than scouring your files for overlooked deductions or forgotten charitable gifts, you can’t do much at this point to trim your 2014 tax bill—with one important exception. You can fund an individual retirement account for 2014, Roth or traditional, right up until April 15. But that’s a hard deadline, even if you get an extension.

As long as your income is below certain thresholds—$70,000 for single filers if you are covered by a retirement plan at work, $116,000 for married couples filing jointly—you’ll be able to deduct at least part of your contribution to a traditional IRA, thus trimming your tax bill. The most you can put in for 2014 is $5,500, and $6,500 if you’re 50 or older.

Once you’ve scrambled to fund your IRA, carve out some time to think about how you want to invest it. A study by Vanguard found that between January and April—i.e., tax season—IRA contributions are more likely to end up in money market funds (which nowadays pay zilch). And those last-minute investments are also more likely to be left to languish in cash.

Two more last-minute moves can cut your tax bill, though not as much as the IRA contributions. One: Those with self-employment income can still fund a SEP-IRA for 2014. And two: If you have a health savings account, you can still top off your 2014 plan—a max of $3,300 for singles, $6,550 for families—and those contributions are also deductible.

Questions? You’re pretty much on your own. The IRS phone lines are so swamped and undermanned that even the agency urges taxpayers to go to IRS.gov for help. Taxpayer advocate Nina Olson recently reported that only 25% of taxpayers are getting through to a live person, with a wait time of 22 minutes. Really stumped? File for an extension, advises Luscombe.

How about hiring a tax preparer on April 14? You might find a pro who’ll take you on, says Labant, but be prepared to have him or her file an extension for you and then help you out once the crunch is over.

Another option for more than two-thirds of taxpayers: As long as your income is below $60,000, you can get access to free commercial tax filing software via IRS free file.

In your dash to the finish line, don’t make dumb mistakes. Those include math errors, the wrong Social Security number (yours or your dependents’), and no signature on a paper return.

Those flubs can hold up your return (and your refund). What’s worse are mistakes that cost you money. To make sure you’re not missing any deductions (or failing to report any income), Labant suggests this extra step. “Sit back and compare your return to last year’s,” she says. Is there a deduction you took before that’s missing this year? Or an income source you reported for 2013 that escaped your 2014 return?

No time for even that quick exercise? I implore you: Seriously think about filing for an extension.

And don’t make a perfectly understandable flub. This year, you have a brand new chance to mess up. For the first time, you have to report whether you had health insurance last year (and possibly pay a penalty if you don’t). “Any time there’s something new, there’s a high error rate,” says Luscombe.

This requirement is simple enough if you got coverage through work or Medicare—you just check a box. Things get thornier if you bought an individual policy on an insurance marketplace and got a tax credit to subsidize your premium (hello, Form 8962), or if you’re applying for an exemption or calculating your penalty (Meet Form 8965).

To make matters worse, the federal government sent out 800,000 incorrect 1095-A forms to folks who bought policies on an exchange. Plus, H&R Block estimates that about half of those who got subsidies have to repay at least some of the money.

You can read about all of this at the IRS Affordable Care Act Q&A page. That could take some time. You know you can get an extension, right?

Remember: You can take a do-over. If you push through to make the deadline, then wake up on April 16 and realize you messed up, you can file an amended return. However, you might want to wait a few weeks, says Luscombe. That way the IRS won’t process your second return first and treat your original return as the amended one.

Vow to reform your ways. Do you hate the stress of filing at the last minute? “Don’t procrastinate again next year,” says Labant. Duly noted. Right after I file for my extension.

MONEY Taxes

For Some Retirees, April 1 is a Crucial Tax Deadline

If you recently reached your 70s and aren't yet drawing money from your tax-deferred retirement accounts, you need to act fast.

For anyone who turned 70½ last year and has an individual retirement account, April 15 isn’t the only tax deadline you need to pay attention to this time of year.

With a traditional IRA, you must begin taking money out of your account after age 70½—what’s known as a required minimum distribution (RMD). And you must take your first RMD by April 1 of the year after you turn 70½. After that, the annual RMD deadline is December 31. After years of tax-deferred growth, you’ll face income taxes on your IRA withdrawals.

Figuring out your RMD, which is based on your account balance and life expectancy, can be tricky. Your brokerage or fund company can help, or you can use these IRS worksheets to calculate your minimum withdrawal.

Failure to pull out any or enough money triggers a hefty penalty equal to 50% of the amount you should have withdrawn. Despite the penalty, a fair number of people miss the RMD deadline.

A 2010 report by the Treasury Inspector General estimated that every year as many as 250,000 IRA owners miss the deadline for their first or annual RMD, failing to take distributions totaling some $350 million. That generates potential tax penalties of $175 million.

The rules are a bit different with a 401(k). If you’re still working for the company that sponsors your plan, you can waive this distribution rule until you quit. Otherwise, RMDs apply.

“It’s becoming increasingly common for folks to stay in the workforce after traditional retirement age,” says Andrew Meadows of Ubiquity Retirement + Savings, a web-based retirement plan provider specializing in small businesses. “If you’re still working you can leave the money in your 401(k) and let compound interest continue to do its work,” says Meadows.

What’s more, with a Roth IRA you’re exempt from RMD rules. Your money can grow tax-free indefinitely.

If you are in the fortunate position of not needing the income from your IRA, you can’t skip your RMD or avoid income taxes. You may want to reinvest the money, gift it, or donate the funds to charity, though a law that allowed you to donate money directly from an IRA expired last year and has not yet been renewed. Another option is to convert some of the money to a Roth IRA. You’ll owe income taxes on the conversion, but never face RMDs again.
Whatever you do, if you or someone you know is 70-plus, don’t miss the April 1 deadline. There’s no reason to give Uncle Sam more than you owe.

 

MONEY Taxes

11 Smart Ways to Use Your Tax Refund

Tax refund check with post-it saying "$$$ for Me"
Eleanor Ivins—Getty Images

You could pay down debt, travel, tend to your health, or shrink your mortgage, among many other ideas.

Here we are, in the thick of tax season. That means many mailboxes and bank accounts are receiving tax refunds. A tax refund can feel like a windfall, even though it’s really a portion of your earnings from the past year that the IRS has held for you, in case you owed it in taxes. Still, it’s a small or large wad of money that you suddenly have in your possession. Here are some ideas for how you might best spend it.

First, though, a tip: If you’re eager to spend your refund, but haven’t yet received it, you can click over to the IRS’s “Where’s My Refund?” site to track its progress through the IRS system. Now on to the suggestions for things to do with your tax refund:

Pay down debt: Paying down debt is a top-notch idea for how to spend your tax refund — even more so if you’re carrying high-interest rate debt, such as credit card debt. If you owe $10,000 and are being charged 25% annually, that can cost $2,500 in interest alone each year. Pay down that debt, and it’s like earning 25% on every dollar with which you reduce your balance. Happily, according to a recent survey by the National Retail Federation, 39% of taxpayers plan to spend their refund paying off debt.

Establish or bulk up an emergency fund: If you don’t have an emergency fund, or if it’s not yet able to cover your living expenses for three to nine months, put your tax refund into such a fund. You’ll thank yourself if you unexpectedly experience a job loss or health setback, or even a broken transmission.

Open or fund an IRA: You can make your retirement more comfy by plumping up your tax-advantaged retirement accounts, such as traditional or Roth IRAs. Better yet, you can still make contributions for the 2014 tax year — up until April 15. The maximum for 2014 and 2015 is $5,500 for most folks, and $6,500 for those 50 or older.

Add money to a Health Savings Account: Folks with high-deductible health insurance plans can make tax-deductible contributions to HSAs and pay for qualifying medical expenses with tax-free money. Individuals can sock away up to $3,350 in 2015, while the limit is $6,650 for families, plus an extra $1,000 for those 55 or older. Another option is a Flexible Spending Account (FSA), which has a lower maximum contribution of $2,550. There are a bunch of rules for both, so read up before signing up.

Visit a financial professional: You can give yourself a big gift by spending your tax refund on some professional financial services. For example, you might consult an estate-planning expert to get your will drawn up, along with powers of attorney, a living will, and an advance medical directive. If a trust makes sense for you, setting one up can eat up a chunk of a tax refund, too. A financial planner can be another great investment. Even if one costs you $1,000-$2,000, they might save or make you far more than that as they optimize your investment allocations and ensure you’re on track for a solid retirement.

Make an extra mortgage payment or two: By paying off a little more of your mortgage principle, you’ll end up paying less interest in the long run. Do so regularly, and you can lop years off of your mortgage, too.

Save it: You might simply park that money in the bank or a brokerage account, aiming to accumulate a big sum for a major purchase, such as a house, new car, college tuition, or even starting a business. Sums you’ll need within a few or as many as 10 years should not be in stocks, though — favor CDs or money market accounts for short-term savings.

Invest it: Long-term money in a brokerage account can serve you well, growing and helping secure your retirement. If you simply stick with an inexpensive, broad-market index fund such as the SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, or Vanguard Total World Stock ETF, you might average as much as 10% annually over many years. A $3,000 tax refund that grows at 10% for 20 years will grow to more than $20,000 — a rather useful sum.

Give it away: If you’re lucky enough to be in good shape financially, consider giving some or all of your tax refund away. You can collect a nice tax deduction for doing so, too. Even if you’re not yet in the best financial shape, it’s good to remember that millions of people are in poverty and in desperate need of help.

Invest in yourself: You might also invest in yourself, perhaps by advancing your career potential via some coursework or a new certification. You might even learn enough to change careers entirely, to one you like more, or that might pay you more. You can also invest in yourself health-wise, perhaps by joining a gym, signing up for yoga classes, or hiring a personal trainer. If you’ve been putting off necessary dental work, a tax refund can come in handy for that, too.

Create wonderful memories: Studies have shown that experiences make us happier than possessions, so if your financial life is in order, and you can truly afford to spend your tax refund on pleasure, buy a great experience — such as travel. You don’t have to spend a fortune, either. A visit to Washington, D.C., for example, will get you to a host of enormous, free museums focused on art, history, science, and more. For more money, perhaps finally visit Paris, go on an African safari, or take a cruise through the fjords of Norway. If travel isn’t of interest, maybe take some dance or archery lessons, or enjoy a weekend of wine-tasting at a nearby location.

Don’t end up, months from now, wondering where your tax refund money has gone. Make a plan, and make the most of those funds, as they can do a lot for you. Remember, too, that you may be able to split your refund across several of the options above.

MONEY stocks

10 Smart Ways to Boost Your Investing Results

stacks of coins - each a different color
Alamy

You don't have to be an investing genius to improve your returns. Just follow a few simple steps.

Recent research shows that people who know their way around investing and finance racked up higher annual returns (9.5% vs. 8.2%) than those who don’t. Here are 10 tips that will help make you a savvier investor and better able to achieve your financial goals.

1. Slash investing fees. You can’t control the gains the financial markets deliver. But by sticking to investments like low-cost index funds and ETFs that charge as little as 0.05% a year, you can keep a bigger portion of the returns you earn. And the advantage to doing so can be substantial. Over the course of a career, reducing annual fees by just one percentage point can boost the size of your nest egg more than 25%. Another less commonly cited benefit of lowering investment costs: downsizing fees effectively allows you to save more for retirement without actually putting aside another cent.

2. Beware conflicted advice. Many investors end up in poor-performing investments not because of outright cons and scams but because they fall for a pitch from an adviser who’s really a glorified salesman. The current push by the White House, Department of Labor and Securities and Exchange Commission to hold advisers to a more rigorous standard may do away with some abuses. But the onus is still on you to gauge the competence and trustworthiness of any adviser you deal with. Asking these five questions can help you do that.

3. Gauge your risk tolerance. Before you can invest properly, you’ve got to know your true appetite for risk. Otherwise, you could end up bailing out of investments during market downturns, turning paper losses into real ones. Completing a risk tolerance questionnaire like this one from RealDealRetirement’s Retirement Toolbox can help you assess how much risk you can reasonably handle.

4. Don’t be a “bull market genius.” When the market is doing well and stock prices are surging, it’s understandable if you assume your incredible investing acumen is responsible for those outsize returns. Guess what? It’s not. You’re really just along for the ride. Unfortunately, many investors lose sight of this basic fact, become overconfident, take on too much risk—and then pay dearly when the market inevitably takes a dive. You can avoid such a come-down, and the losses that accompany it, by leavening your investing strategy with a little humility.

5. Focus on asset allocation, not fund picking. Many people think savvy investing consists of trying to identify in advance the investments that will top the performance charts in the coming year. But that’s a fool’s errand. It’s virtually impossible to predict which stocks or funds will outperform year to year, and trying to do so often means you’ll end up chasing hot investments that may be more prone to fizzle than sizzle in the year ahead. The better strategy: create a diversified mix of stock and bond funds that jibes with your risk tolerance and makes sense given the length of time you plan to keep your money invested. That will give you a better shot at getting the long-term returns you need to achieve a secure retirement and reach other goals while maintaining reasonable protection against market downturns.

6. Limit the IRS’s take. You should never let the desire to avoid taxes drive your investing strategy. That policy has led many investors to plow their savings into all sorts of dubious investments ranging from cattle-breeding operations to jojoba-bean plantations. That said, there are reasonable steps you can take to prevent Uncle Sam from claiming too big a share of your investment gains. One is doing as much of your saving as possible in tax-advantaged accounts like traditional and Roth 401(k)s and IRAs. You may also be able to lower the tab on gains from investments held in taxable accounts by investing in stock index funds and tax-managed funds that that generate much of their return in the form of unrealized long-term capital gains, which go untaxed until you sell and then are taxed at generally lower long-term capital gains rates.

7. Go broad, not narrow. In search of bigger gains, many investors tend to look for niches to exploit. Instead of investing in a broad selection of energy or technology firms, they’ll drill down into solar producers, wind power, robotics, or cloud-computing firms. That approach might work, but it can also leave you vulnerable to being in the wrong place at the wrong time—or the right place but the wrong company. Going broader is better for two reasons: it’s less of a guessing game, and the broader you go the lower your investing costs are likely to be. So if you’re buying energy, tech or whatever, buy the entire sector. Better get, go even broader still. By investing in a total U.S. stock market and total U.S. bond market index fund, you’ll own a piece of virtually all publicly traded U.S. companies and a share of the entire investment-grade bond market. Throw in a total international stock index fund and you’ll have foreign exposure as well. In short, you’ll tie your portfolio’s success to that of the broad market, not just a slice of it.

8. Consider the downside. Investors are by and large an optimistic lot, otherwise they wouldn’t put their money where their convictions are. But a little skepticism is good too. So before putting your money into an investment or embarking on a strategy, challenge yourself. Come up with reasons your view might be all wrong. Think about what might happen if you are. Crash-test your investing strategy to see how you’ll do if your investments don’t perform as well as you hope. Better to know the potential downside before it occurs than after.

9. Keep it simple. You can easily get the impression that you’re some kind of slacker if you’re not filling your portfolio with every new fund or ETF that comes out. In fact, you’re better off exercising restraint. By loading up on every Next Big Thing investment the Wall Street marketing machine churns out you run the risk of di-worse-ifying rather than diversifying. All you really need is a portfolio that mirrors the broad U.S. stock and bond markets, and maybe some international exposure. If you want to go for more investing gusto, you can consider some inflation protection, say, a real estate, natural resources, or TIPS fund. But I’d be wary about adding much more than that.

10. Tune out the noise. With so many investing pundits weighing in on virtually every aspect of the financial markets nearly 24/7, it’s easy to get overwhelmed with advice. It might make sense to sift through this cacophony if it were full of investing gems, but much of the advice, predictions, and observations are trite, if not downright harmful. If you want to watch or listen to the parade of pundits just to keep abreast of the investing scuttlebutt, fine. Just don’t let the hype, the hoopla, and the hyperbole distract you from your investing strategy.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

More From RealDealRetirement.com:

 

MONEY retirement savings

Borrowing From Your 401(k) Might Not Be Such a Bad Thing

carton of gold eggs, some are empty
GP Kidd—Getty Images

Most loans get paid back. It's cashing out that's the problem.

“Leakage,” using 401(k) or IRA savings to pay for anything other than retirement, has become something of a bad word in the personal finance world. One policy wonk, Matt Fellowes, the founder and CEO of HelloWallet, took the metaphor even further when he wrote that “the large rate and systematic quality of the non-retirement uses of DC [defined contribution] assets indicates that these plans are now being ‘breached.’ This is a massive systematic problem that now affects 1 out of every 4 participants, on average—which is more like a gaping hole in the DC boat than a pesky ‘leak.’

But leaks come in different shapes and sizes, and it turns out that some of them—such as taking loans from your own account, which you then pay back with interest—are less dangerous to your future financial security than others. Data from Vanguard shows that 18% of people participating in plans offering loans had a loan outstanding in 2013, and about 11% took out a new loan that year, which sounds like a very high rate. But the average loan was about $9,500 and most of it gets repaid, so it actually doesn’t represent a permanent drain on retirement savings. “Loans are sometimes criticized as a source of revolving credit for the young, but in fact they are used more frequently by mid-career participants,” note Alicia Munnell and Anthony Webb of the Center for Retirement Research at Boston College.

The real problem is what is known as a “cash-out,” when employees take a lump-sum distribution when they change jobs, instead of keeping their savings in their employer’s plan, transferring it to their new employer’s 401(k), or rolling it into an IRA. These cash-outs are subject to a 10% early withdrawal penalty (if you’re under the age of 59½) and a 20% withholding tax. Vanguard reports that 29% of plan participants who left their jobs in 2013 took a cash distribution. Younger participants with lower balances are more likely to cash out than older ones.

Equally risky, although more difficult to obtain, are “hardship withdrawals,” which allow 401(k) plan participants to access funds if they can prove that they face an “immediate and heavy financial need,” such as to prevent an eviction or foreclosure or to pay for postsecondary tuition bills. As with cash-outs, these withdrawals are subject to a 10% penalty as well as 20% withholding for income tax. (You can take a non-penalized withdrawal if you become permanently disabled or to cover very large medical expenses.) Employees must prove that they’ve exhausted every other means, including taking a loan from their 401(k). The rules governing IRAs are much more relaxed and include taking penalty-free withdrawals of up to $10,000 to buy, build, or rebuild a first home or even to pay for medical insurance for those unemployed for 12 weeks or more—situations one might argue it would be better to have established a six-month emergency or house fund to cover instead of taking from your IRA.

Policy watchers such as Munnell and Webb recommend tightening up regulations to reduce leakage, arguing in particular that allowing participants to cash out of 401(k)s when they change jobs is “hard to defend” and that the mechanism could be closed down entirely by changing the law to prohibit lump-sum distributions upon termination. It would also make sense to make the rules for withdrawals from IRAs as strict as those from 401(k)s, since more and more assets are moving in that direction as people leave jobs and open rollover IRAs.

But perhaps the biggest lesson of leakage is that if people are reaching into their retirement funds to pay for basic needs such as housing or health insurance, they may be better off not participating in a 401(k) until they have enough emergency savings under their belt. Contributing to a retirement plan is important, but not if you turn your 401(k) into a short-terms savings vehicle and ignore basic budgeting and emergency planning.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY Ask the Expert

When Investment Growth, Income, and Safety Are All Priorities

Investing illustration
Robert A. Di Ieso, Jr.

Q: I’m 64 and retired. My wife is 54 and still working, but I’m asking her to join me in retirement. We have about $1 million in savings, with about half in an IRA and the rest in CDs. How can try I try to preserve the principal, generate about $2,000 in monthly income until I collect Social Security at age 70, and somehow double my investment? — Rajen in Iowa

A: The first thing you need to ask yourself is what’s really more important: Growth, income, or safety? You say you want to preserve your principal – and your large cash position suggests that you are risk averse – but you also say you want to double your investment.

“Why do you need to double your investment?” asks Larry Rosenthal, a certified financial planner and president of Rosenthal Wealth Management Group in Manassas, VA. “Everybody likes the idea of doubling their investment, but there’s a high cost if it doesn’t work out.”

Given that you’re already retired, doubling your investment is a tall order. You probably don’t have that kind of time. At a 5% annual return, it would take you more than 14 years, and that’s without tapping your funds for income along the way. Nor can you afford to take on too much additional risk.

Either way, you do need to rethink how you have your assets allocated.

A 50% cash position is likely far too much, especially with interest rates as low as they are. “You’re effectively earning a negative return,” factoring in inflation, says Rosenthal.

And while cash is a great buffer for down markets, the value is lost in the extreme: The portion of your portfolio that is invested in longer-term assets such as stocks and bonds needs to do double duty to earn the same overall return.

If generating growth and income are both priorities, “look at shifting some of that cash into dividend paying stocks, a bond ladder, an annuity, or possibly a combination of the three,” says Rosenthal, who gives the critical caveat that the decision of how to invest some of this cash will depend on how your IRA money is invested.

Meanwhile, you should take a closer look at the pros and cons of claiming Social Security at full retirement age, which is 66 in your case, or waiting until you’re 70 years old.

The current conventional wisdom is to hold off taking Social Security as long as possible in order to maximize the monthly benefit. While that advice still holds true for many people, you need to look at the specifics of your situation – as well as that of your wife. The best way to know is to run the numbers, which you can do at Social Security Timing or AARP.

The tradeoff of waiting to claim your benefit, says Rosenthal, is spending down more of your savings for six years. You may in fact do better by keeping that money invested.

What’s more, “if you die, you can pass along your savings,” adds Rosenthal. But you don’t have that type of flexibility with Social Security benefits.

MONEY

25 Ways to Get Smarter About Money Right Now

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John Lund—Getty Images

Small steps that can make a big difference.

Retirement planning is serious business that requires diligence and patience. But a quick tip, or even an irreverent one, can sometimes be helpful, too. Here are 25 observations from my 30 years of writing about retirement and investing that may spur you to plan more effectively (or to start planning if you’ve been putting it off).

1. If you’re not sure whether you’re saving enough for retirement, you probably aren’t. You can find out for sure pretty easily, though, by going to this Am I Saving Enough? tool.

2. There’s an easy way not to outlive your money: die early. But I think most people would agree that coming up with a realistic and flexible retirement income plan is a more reasonable way to go.

3. If your primary rationale for doing a Roth 401(k) or Roth IRA instead of a traditional version is that “tax free is always better than tax-deferred,” you need to read this story before doing anything.

4. Some people put more thought into whether to have fries with their Big Mac than deciding when to claim Social Security benefits. Unfortunately, giving short shrift to that decision may put those same people at greater risk of having to work behind a fast-food counter late in life to maintain their standard of living.

5. Yes, stocks are risky. But if they weren’t, they wouldn’t be able to generate the high long-term returns that can help you build a sizeable nest egg without devoting a third or more of your income to saving.

6. Just because the mere thought of an immediate annuity makes your eyes glaze over doesn’t mean you shouldn’t consider one for your post-career portfolio. When it comes to retirement income, boring can be beautiful.

7. What do rebalancing your retirement portfolio and flossing have in common? We know we ought to make both part of our normal routine, but many people don’t get around to either as regularly as they should.

8. Lots of people (especially in the media) complain that we’d all be better off if companies would just go back to giving workers check-a-month retirement pensions instead of 401(k) plans. But that’s not gonna happen. So focus your efforts on how to maximize your 401(k) or other savings plan.

9. Target-date funds’ stock-bond allocations can’t match your risk tolerance exactly. But guess what? You don’t need an exact match to invest successfully for retirement. And for most people an inexact target-date portfolio is a lot better than anything they’d build on their own.

10. A really smart fund manager can beat an index fund. Problem is, there’s no way to tell in advance whether a manager is one of the handful who’s truly smart or one of the many who look smart but are just lucky or having a few good years. That’s why you’re better off going with index funds in your retirement portfolio.

11. Your employer’s 401(k) match isn’t really “free.” It’s part of your compensation. Which makes it all the more puzzling why anyone wouldn’t contribute at least enough to his 401(k) to get the full company match.

12. Investing in a fund with high fees is like betting on a racehorse being ridden by a fat jockey. Sure, the horse could still be good enough to win. But do you want to put money on it? A low-cost fund effectively allows you to boost your savings rate and gives you a better shot at building an adequate nest egg and making it last throughout retirement.

13. Every time you move to a new house or apartment do you leave all your furniture and other possessions behind? Then why do so many people fail to consolidate their old 401ks into their current plan or a rollover IRA? (Okay, if the old plan’s investing options are unmatchable, that’s a reason. But seriously, how often is that the case?)

14. A reverse mortgage can be a good option to supplement retirement income if your other resources are coming up short. But be sure to consider a trade-down as well. In fact, you may be able to trade down and then do a reverse mortgage in the future.

15. No rule of thumb can be a substitute for detailed retirement planning. But some rules of thumb are better than no planning at all. And going with a rule of thumb may at least help you get on track toward a secure retirement until you decide to get more serious about your planning.

16. Many people are skittish about investing in bonds these days because they’re worried they’ll get clobbered when interest rates rise. But you know what? Pundits have been predicting bond Armageddon for years and it hasn’t happened. Besides, as this research shows, even at today’s low yields bonds remain an effective way to hedge equity risks and diversify your portfolio.

17. People peddling high-cost variable annuities know that retirement investors love the word “guaranteed.” Which is why as soon as you hear that alluring word, you should ask what, exactly, is being guaranteed and who is doing the guaranteeing? Then ask how much you’re paying for that guarantee and what you’re giving up for it. The answers may surprise and enlighten you.

18. No retirement calculator can truly tell you whether you’re on track for a secure retirement because no tool can fully reflect the uncertainty and complexity of real life. Of course, the same goes for the most sophisticated software and human advisers, too. The reason to fire up a good retirement calculator isn’t to come away with a projection that’s 100% accurate. It’s to get a sense of whether you’re on the right course and see how different moves might improve your prospects.

19. You don’t have to be a financial wiz to invest successfully for retirement. But understanding a few basic principles can improve your investing results. Try this investing quiz to see how much you know.

20. Getting fleeced by an unscrupulous adviser or ravaged by a severe bear market can certainly wreak havoc on your retirement plans. But for most people it’s basic lapses in investing and planning that diminish their retirement prospects the most.

21. Many experts say the 4% rule is broken, that it no longer works in today’s low-return world. Fact is, the 4% rule was never all it was cracked up to be. To avoid running out of money in retirement, plug your spending, income, and investing info into a retirement income calculator capable of assessing the probability that your money will last—then repeat the process every year or so to see if you need to adjust your spending.

22. Diversifying your portfolio can lower risk and boost returns. But if you try to get too fancy and stuff your portfolio with investments from every obscure corner of the market and all manner of arcane ETFs, you may end up di-worse-ifying rather than diversifying.

23. Many retirees pour their savings into “income investments” like dividend stocks and high-yield bonds when they want to turn their savings into reliable income. But such a focus can be dangerous. A better way to go: create a low-cost diversified portfolio that generates both income and growth, and then get the income you need from interest, dividends, and periodic sales of fund or ETF shares.

24. The next time wild swings in the market give you the jitters, don’t look to bail out of stocks and huddle in bonds or cash. Market timing doesn’t work. Instead, do this 15-minute Portfolio Check-Up, and then take these 3 Simple Steps to Crash-Proof Your Portfolio.

25. Financial security is definitely important, but retirement satisfaction isn’t just a question of money. Lifestyle matters, too. Among the lifestyle factors that make for a happier post-career life: maintaining your health, staying active and engaged through occasional work or volunteering, cultivating a circle of friends…and, yes, regular sex.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

More from RealDealRetirement.com:

Social Security: Your 3 Most Pressing Questions Answered

5 Questions To Ask Before Hiring A Financial Adviser

How To Tell If You Can Afford To Retire Early

 

 

 

MONEY College

How to Balance Saving for Retirement With Saving for Your Kids’ College Education

Parents often find themselves between a rock and a hard place when it comes to doing what's best for themselves and their children. One financial adviser offers a formula to make it easier.

It’s a uniquely Gen X personal finance dilemma: Should those of us with young children be socking away our savings in 401(k)s and IRAs to make up for Social Security’s predicted shortfall, or in 529s to meet our children’s inevitably gigantic college tuition bills? Ideally, of course, we’d contribute to both—but that would require considerable discretionary income. If you have to chose one over the other, which should you pick?

There are two distinct schools of thought on the answer. The first advocates saving for retirement over college because it’s more important to ensure your own financial health. This is sort of an extension of the put-on-your-own-oxygen-mask-first maxim, and it certainly makes some sense: Your kids can always borrow for college, but you can’t really borrow for retirement, with the exception of a reverse home mortgage, which most advisers think is a terrible idea.

The flip side of this, however, is that while you can choose when to retire and delay it if necessary, you can’t really delay when your kid goes to college. Moreover, the cost of tuition has been rising at a much faster rate than inflation, another argument for making college savings a priority. Finally, many parents don’t want to saddle their young with an enormous amount of debt when they graduate.

According to a recent survey by Sallie Mae and Ipsos, out-of-pocket parental contributions for college, whether from current income or savings, increased in 2014, while borrowing by students and parents actually dropped to the lowest level in five years, perhaps the result of an improved economy and a bull market for stocks. But clearly, parents often find themselves between a rock and a hard place when it comes to doing what’s best for themselves and their children: While 21% of families did not rely on any financial aid or borrowing at all, 7% percent withdrew money from retirement accounts.

If you’re struggling with this decision, one approach that may help is to let time guide your choices, since starting early can make such a huge difference thanks to the power of compound interest. Ideally, this would mean participating in a 401(k) starting at age 25 and contributing anywhere from 10% to 15%, as is currently recommended. Do that for a decade, and even if your income is quite low, the early saving will put you way ahead of the game and give you more leeway for the next phase, which commences when you have children (or, for the sake of my model, when you’re 35).

As soon as your first child is born, open a 529 or similar college savings account. Put in as much money as possible, reducing your retirement contributions if you have to in order to again take advantage of the early start. Meanwhile, your retirement account can continue to grow on its own from reinvested dividends and, hopefully, positive returns. Throw anything you can into the 529s—from the smallest birthday check from grandma to your annual bonus—in the first five or so years of a child’s life, because pretty soon you will have to switch back to saving for retirement again.

By the time you’re 45, you will have two decades of saving and investing under your belt and two portfolios as a result, either of which you can continue to fund depending on its size and your cost calculations for both retirement and college. You probably also now have a substantially larger income and hopefully might be able to contribute to both simultanously moving forward, or make catch-up payments with one or the other if you see major shortfalls. At this point, however, retirement should once again be the central focus for the next decade—until your child heads off to college and you have start writing checks for living expenses, dorm fees, and textbooks. Don’t worry, you still have another 10 to 15 years to earn more money for retirement, although those contributions will have less long-term impact due to the shorter time horizon.

Of course, this strategy doesn’t guarantee that your kids won’t have to apply for scholarships or take out loans, or that you won’t have to put off retiring until 75. But at least you will know that you did everything in your power to try to plan in advance.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

 

 

 

 

 

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