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Mechanics of 401(k) Plans – Loans

Image courtesy of Stuart Miles at

Image courtesy of Stuart Miles at

Continuing our series of articles on the mechanics of 401(k) plans, today we’ll talk about loans from the account.  As with all of these articles, we’ll refer generically to the plans as 401(k) plans, although they could be just about any Qualified Retirement Plans (QRPs), including 403(b), 457, and other plans.

Unlike IRAs, 401(k) plans allow for the employee-participant to take a loan from the plan.  There are restrictions on these loans, but they can be useful if you need funds for a short-term period and have no other sources.

401(k) Loans

If you have a balance in your 401(k) account, often your plan administrator will have a provision allowing you to take a loan of some of the funds in the account. (Not all plans allow loans – this is an optional provision, not a requirement.)  Sometimes the plan administrator will place restrictions on the use of the loan – such as for education expenses, medical expenses, or certain housing costs.

These loans are limited to the lesser of 50% of your vested balance or $50,000.  If your vested account balance is less than $20,000, you are allowed to take a loan up to $10,000 or 100% of your vested balance.  It is allowed to have more than one loan from your 401(k) plan at a time, but the limits mentioned above apply to the aggregation of all loans at any time.

Loans from your 401(k) plan must be paid back over a specific period of time, not to exceed 5 years from the loan origination.  If the loan is for purchase of the participant’s primary residence, the plan administrator may extend the repayment period of the loan.  In addition, loan payments must be on a set schedule of substantially equal payments, including both interest and principal – and payments must at least be quarterly.  Loan payments are not considered to be plan contributions (when considering annual contribution limits).

If the loan is not repaid according to the schedule, any unpaid balance is considered to be a taxable distribution from the plan – but not a usurpment of rules regarding in-plan distributions.  In other words, if a plan only allows in-plan distributions to employee-participants who are over age 59½ and an employee under that age defaults on a loan, the deemed distribution is not outside the rules of an in-plan distribution.

Loan payments can be suspended for up to one year for a period of absence by the employee-participant, but the original loan repayment period still applies.  In other words, if an employee with a 401(k) loan in repayment status takes a leave of absence and payments are suspended, upon the shorter of his return to work or 1 year, the suspended payments have to be made up.  This is done via either increased payments for the remainder of the loan period, or a lump-sum payment at the end of the period.

Loan payments can also be suspended for employees performing military service – such as called-up reserves.  The time limit of 1 year (as above) doesn’t apply to these suspensions.

Interest on the loan can vary by the 401(k) plan, but most common is to use a rate such as “Prime plus 2%”.

Unless you default on the loan, the proceeds are not taxable, since you’ve only borrowed them and are paying back the funds, usually via payroll deduction.  The payments back into the plan are taxable income, since they are not considered to be “regular” contributions to the account.

Mechanics of 401(k) Plans – Distribution

Photo courtesy of Sonja Langford on

Photo courtesy of Sonja Langford on

For the next in our series of articles regarding the mechanics of 401(k) plans, we’ll review distributions from the plan.  As with our other articles in this series, we’re referring to all sorts of qualified retirement plans (QRPs) – including 401(k), 403(b), 457, and others – generically as 401(k) plans throughout.

There are several types of distributions from 401(k) plans to consider.  Distributions before retirement age and after retirement age are the two primary categories which we’ll review below.  Another type of distribution is a loan – which will be covered in a subsequent article.

But first, we need to define retirement age.  Generally speaking, retirement age for your 401(k) plan is 59½, just the same as with an IRA.  However, if you leave employment at or after age 55, the operative age is 55.  If you have left employment before age 55, retirement age is 59½. This means that when you have reached retirement age you have access to the funds in your account without the early distribution penalty. (For government jobs with a 457 plan, retirement age is whenever you leave employment – no set age is defined. If you move your funds from the 457 plan to any other type of plan, such as an IRA or 401(k) you lose this provision and must abide by the retirement age for your new plan.)

Distributions before retirement age

When you take a distribution from your 401(k) account before you have reached retirement age (as defined above) – you will possibly owe ordinary income tax and a penalty for early distribution from the account.  This is if you take the distribution without rolling it over into some other sort of tax-deferral vehicle, such as an IRA or 401(k) plan.

If you withdraw funds or securities from your 401(k) plan and put the money into a non-deferred account (or just spend it), it is considered taxable income to you.  Ordinary income tax will apply to the pre-tax amounts distributed from your account.

The one exception: If you happen to have post-tax funds in your account – that is, if you have contributed funds that were taxable prior to your contribution to the account – when these funds are distributed there will be no tax on the distribution.  Any growth of the funds (interest received, capital gains, dividends, etc.) would be taxable, but the post-tax contributions are free from additional tax.  All other funds in your 401(k) account are taxable upon distribution.

The other exception: If the funds are rolled over into another tax-deferred account such as an IRA, another 401(k), or any other QRP, there should be no tax on this distribution.

The 10% penalty will apply to funds withdrawn prior to retirement age if one of the 72(t) exceptions does not apply. Some of these exceptions include (with limits): first-time home purchase, medical expenses, and education expenses, among other things.  See the article at this link for a complete list of 72(t) exceptions.

Distributions after retirement age

Withdrawals after retirement age are the same as withdrawals before retirement age, except for the 10% penalty.  If you are older than retirement age (defined above) you will not be subject to the 10% penalty on funds withdrawn from the account – because this is one of the 72(t) exceptions, the most common one used.

So pre-tax contributions and growth in the account will be taxed as ordinary income unless rolled over into another tax-deferred account.  Post-tax contributions to the account will be tax-free upon distribution.

Distributions including partly pre-tax and partly post-tax

If your account includes some after-tax money in addition to pre-tax money, the general rule is that any distribution from the account includes pro-rata amounts of some pre-tax and some post-tax money.  For example, if a 401(k) account contains $100,000 in total, of which $10,000 is post-tax contributions, for every dollar withdrawn from the account, 10¢ is tax-free, and 90¢ is taxable.  This is known in the industry as the “cream in the coffee” rule – as in, once you have cream (post-tax money) in your coffee (your 401(k) plan), every sip (distribution) contains some cream along with the coffee.

There are ways to separate the cream from the coffee, all controversial and subject to significant restrictions.  We’ll cover that in a later article.

Book Review – Entrepreneurial Finance

9780071825399_p0_v3_s260x420This book is a fantastic introduction to any would-be or current entrepreneur looking to understand the numbers and money behind what it takes to succeed. Steven Rogers approaches the subject of entrepreneurial finance in a way that makes sense to the reader and allows then to understand how the finance concepts work for and potentially against the entrepreneur. Mr. Rogers has taught at the Northwestern Kellogg School and is currently a senior lecturer at Harvard University.

Pulling from an extraordinary amount of personal experience Mr. Rogers guides the reader through reading and interpreting different financial statements as well as gives real life examples of companies, personal experience and the experience of a former student considering changing jobs and what the cost analysis of the change would be.

Not surprisingly, Mr. Rogers’ concepts can be applied to personal finance – a plus for anyone who reads the book. As some of our readers know I teach finance classes and will be using this book to augment the lessons I deliver to students.

It’s easy to read and straight to the point. Mr. Rogers wastes no time in telling it like it is and how things are and what to expect as readers journey into the world of starting, acquiring and running businesses – which is what many budding entrepreneurs need, but seldom get except from personal trials and tribulations.

Are Target Date Funds Off Target?


On Target

It seems that an easy fix for saving for retirement for many folks is to simply choose a target date fund. Generally how target date funds work is a fund company will have a set of different funds for an investor to pick from depending on a best guess estimate of when the investor wants to retire.

For example, an investor who’s 30 years old and wants to retire at age 65 may choose a 2045 fund or a 2050 fund. In this example since the investor is age 30 in the year 2014, 30 more years gets him to 2044. Most target date funds are dated in 5 year increments. If the investor was age 60 and wanting to retire at age 65, then he may choose a 2020 fund to correspond to his timeline.

Generally, the goal of target date funds is to follow a glide path that allocates the investor’s assets more conservatively as the investor approaches retirement. Then at the target retirement year, remain fixed in a more conservative allocation. The problem lies in the fact that of all the target dates funds out there, there is little conformity among glide paths – that is, different target date funds from different companies may have the same target year to retire, but may have significantly different asset allocations.

In addition, recent research has shown that target date funds’ approach in moving to more conservative assets such as bonds when investors are nearing retirement may be counterproductive. Since as an investor’s portfolio is at its largest and can therefore take advantage of compounding more efficiently, moving to conservative assets can actually hinder performance in the years right before the investor retires.

So what does an investor do? First, determine what options you have available from different target date funds. Some are better than others – especially when it comes to expenses. Next, research the fund you plan on investing in. You can also find a competent financial planner that can do the leg work for you.

Finally, determine if a target date fund is right for you. For many folks it’s a simple way to start saving for retirement in their 401(k), as well as in many company plans it’s the default option if an investor doesn’t pick a fund outright. You don’t have to have a target date fund in order to retire with a decent nest egg. There are many competent planners that can have an excellent discussion with you to determine which funds and which allocations are appropriate for you.

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Types of Rollovers Not Subject to the Once-Per-Year Rule

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Photo courtesy of Paula Borowska on

In a previous article we discussed the changes to the IRA One-Rollover-Per-Year rule.  There are certain types of rollovers that are not included in that restriction, detailed below.

As mentioned in the earlier article, trustee-to-trustee transfers are not considered “rollovers” by the IRS regarding this rule.  So you are allowed to make as many trustee-to-trustee transfers in a year as you like – no restrictions on these kinds of transfers at all.  This includes trustee-to-trustee transfers from or to IRAs, 401(k)s, 403(b)s, or any eligible plan.

In addition, a rollover from an IRA into a 401(k) or other Qualified Retirement Plan (QRP) is not impacted by this rule.  This means that you can roll funds out of your IRA and into your employer’s 401(k) plan with no restriction – regardless of whether or not you have already made an IRA-to-IRA rollover in the previous 12 months.

Similarly, a rollover from a 401(k) or other QRP into an IRA is also not covered by the once-per-year rule.  Just like going the other direction, you could rollover funds from your 401(k) plan into an IRA (via a non-direct transfer) and it will not count against the one-rollover-per year restriction.

Roth IRA conversions do not count toward the one-rollover-per-year rule either.  This could be a method for moving funds around if you’ve been otherwise restricted by a prior indirect or 60-day rollover.  Even though moving money from a traditional IRA (or QRP) to a Roth IRA via a conversion is technically termed a rollover, these conversions are not counted toward the once-per-year rollover restriction.

Mechanics of 401(k) Plans – Vesting

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Image courtesy of vectorolie at

In this article in our series on the mechanics of 401(k) plans, we’ll be covering the concept of vesting.  As with the other articles in the series, we’ll refer specifically to 401(k) plans throughout, but most of the provisions apply to all types of Qualified Retirement Plans (QRPs), which go by many names: 401(k), 403(b), 457, etc..

Vesting refers to the process by which the employer-contributed amounts in the 401(k) plan become the unencumbered property of the employee-participant in the plan.  Vesting is based upon the tenure of the participant as an employee of the employer-sponsor of the plan.

Generally, when an employee first begins employment there is a period of time when the employer wishes to protect itself from the circumstance of the new employee’s leaving employment within a relatively short period of time.  Vesting is one way that the employer can protect itself from handing over employer-matching funds from the 401(k) plan if the employee leaves the job very soon.  Vesting can also apply to other employer-provided benefits such as a pension, profit-sharing plan, or stock purchase plan.

It is important to note that you are ALWAYS vested in the funds that you have deferred into the 401(k) plan.  Vesting refers to employer-provided benefits.

Vesting can be done in three ways: immediate, cliff, or graded.  Immediate vesting is just as the name implies – the employee is 100% vested in employer-provided amounts immediately, with no limitations.  In this case, if the employee left the company immediately after his or her first paycheck where 401(k) amounts were contributed on his or her behalf, those amounts would be available to rollover into an IRA or other QRP right away.

Cliff vesting refers to a process where a specific period of time must pass, and after that time has passed the employee is 100% vested in the employer-provided amounts.  Until that time period has passed, the employee has a zero percent claim to the employer-provided amounts in the plan.  Federal law prescribes a 3-year limit on cliff vesting schedules for QRPs – any length of time less than or equal to 3 years can be an applicable cliff vesting schedule.

Graded vesting refers to a process where a series of time periods pass, and after each of these periods of time a portion of the employer-provided amounts in the 401(k) plan becomes the property of the employee.  Gradually the employee gains 100% vesting (access) to the employer-provided amounts.  An example of a 4-year vesting schedule would provide vesting of 25% per year at the end of each of the four years.  After the end of the first year of employment, 25% of the employer-matching funds are vested.  After two years, 50%; after three years, 75%; and after the fourth year the funds are 100% vested with the employee.  Federal law puts a limit of 6 years as the maximum number of years a vesting schedule can run.

More Money Isn’t the Answer

The Best of Eddie Money

How many times have we said or heard the phrase, “If I only had more money…”? Whether wanting to purchase a new car, house or trying to pay down bills such as credit card debt and student loans we can fall into the trap of thinking that more money will be the answer to our problems. Most often, this is not the case.

The question we face is how we manage our money – not how much we make. Granted folks need a certain amount of money to survive (although there are some extremists that would argue otherwise) but think of it this way: if someone is poor at managing their money they currently make, how is an increase in income going to make them a better money manager?

Let’s give this some perspective (shout out to last week’s post). Let’s say you were a bank and you were lending out money to a business owner. Every year, the business owner comes to you and asks for more money. After looking at the business’s financials and records you see that the money you’ve lent in the past was blow through in a matter of weeks – yet your client still asks for more telling you that if only they had more money, they’d be in a better financial position.

After a while, you’d cut the client off. It’s clear they cannot manage their money. Sadly, some folks think that this is the way to get out of debt – by adding more. Individuals will apply for more credit cards in order to get out of the current credit card trap they’re in – which often compounds their money troubles.

Unfortunately there are some higher powers that are in the same boat. Illinois for example, has one of the highest tax revenues among the US states (Census 2012), yet ranks among the worst states with unfunded pension liabilities ($97 billion in 2013). Here’s a glaring example that more money is not the answer.

Government irresponsibility aside, here are some things you can do to better manage they money you do have:

  1. Pay yourself first. Set aside a certain amount of your income each paycheck for retirement and savings.
  2. Live within your means. Stop over spending and before making a purchase ask yourself, “Do I really need this?”
  3. Admit you are horrible at managing money.
  4. Commit to educating yourself about money, personal finance, and investing. There are several books (three on this blog) that can help you build a solid financial education foundation.
  5. Practice frugality. Clip coupons, shop for deals, ask for discounts.
  6. Be thankful for what you have. Being content with what you have and grateful for what you’ve been blessed with can help combat materialism.
  7. Forget about the Joneses. Don’t keep up with them – they may be on the wrong road!
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Social Security Spousal Benefits After a Divorce

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Photo courtesy of danka peter on

We’ve discussed many different factors about Social Security Spousal Benefits, but what happens to Spousal Benefits after the couple has divorced?

We know that a divorcee can file for Spousal Benefits if the marriage lasted for at least 10 years – but only after a 2-year period has passed if the ex-spouse has not already filed for benefits.  The only other factors that must be in place are for the ex-spouse to be at least 62 years of age, and of course the ex must have a benefit record to calculate Spousal Benefits from.

On the other hand, if a couple is divorcing and one of the spouses (soon to be ex-spouses) has already filed for his or her own Social Security benefits, the other spouse can file for Spousal Benefits either before or after the divorce is finalized with no waiting period, as long as they were married for one year or longer.

This differs from the usual explanation of divorcee Spousal Benefits in a couple of ways: first off, if the other spouse has not already filed, there is a two year waiting period after the divorce to allow the person to file for Spousal Benefits.  Secondly, if the benefits have not already started, the marriage must have been in existence for 10 years (before the divorce) for the ex-spouse to be eligible for Spousal Benefits.

A planning point can be illustrated by the following example:  A couple, Jan and Dean, who were married for 30 years and are going through a divorce.  Dean is 66 years old, and Jan is 62.  Dean has not filed for his Social Security benefits, preferring to delay until age 70.  Jan has also not filed for benefits, however, after the divorce she feels that she may need the benefits to augment her income.

Jan could file for her own benefit either before or after the divorce, that event won’t have an impact on her own retirement benefit.  However, if she needs the Spousal Benefit in addition to her own benefit, she would have to wait until two years have passed after the divorce in order to be eligible.  The limiting factor is that Dean has not filed for his own benefit.

Now, if Dean was to file and suspend his benefit, there is no negative for him – file and suspend has no downside for him.  On the other hand, by Dean’s filing and suspending his own benefit, he has enabled Jan to file for Spousal Benefits, either before or after the divorce is finalized.  Otherwise Jan would have to wait until two years after the divorce is final to be eligible for Spousal Benefits.

It’s important to note that deemed filing would apply to Jan if Dean has filed for his benefits – meaning that if Dean files or files and suspends before Jan files for her own benefit, she is required to filed for both her own benefit and the Spousal Benefit at the same time.  This is because she is under full retirement age, and is eligible for a Spousal Benefit in addition to her own benefit, so she is deemed to have filed for both in these circumstances.

Mechanics of 401(k) Plans – Employer Contributions

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Photo courtesy of Lumen Bigott on

This is the second post in a series of posts that explain the mechanics of a 401(k) plan.  As mentioned previously, there are many types of Qualified Retirement Plans (collectively called QRPs) that share common characteristics.  Some of these plans are called 401(k), 403(b), and 457.  In these articles we’ll simply refer to 401(k) plans to address common characteristics of all of these QRPs.

Employer Contributions

Many companies provide a matching contribution to the 401(k) plan – and sometimes there is a contribution made to a QRP on your behalf no matter if you have contributed your own deferred salary or not.

Most of the time these matching contributions are stated as x% of the first y% of contributions to the account.  An example would be “50% of the first 6%”, meaning if you contribute 6% of your salary to the plan, the company will match that contribution with 3% (50% of your contribution).  This matching rate is up to the company, but it must be applied without discrimination for all employee-participants in the plan.

Sometimes the company designates that your contribution must be invested solely in company stock – this is less common these days, but it still occurs.  Otherwise, once you’re vested in the plan, this matching contribution is your money. (We’ll cover vesting later.)


As mentioned previously, most often employer contributions are in the form of matching contributions – dependent upon employee-participants’ making deferrals into the program in order for the company to make a contribution to your account.

In a 50% of the first 6% match plan (as an example), if your salary is $30,000 and you defer 5% or $1,500 into the plan, your employer would match that with a $750 contribution.  As mentioned in the earlier post on saving/contributing to your 401(k) plan, this deferral could result in a tax savings of approximately $225 in these circumstances.

When you balance it out, you wind up with $2,250 in your 401(k) account and a tax bill that’s $225 lower.

Spontaneous Contributions

In some cases, the employer makes contributions to your 401(k) plan regardless of whether you defer salary into the plan.  In these cases, called Safe Harbor plans, the employer wants to ensure that there are contributions made on behalf of all employees (to encourage saving and participation) and to ensure that there is no discrimination toward higher-salaried employees.  If there were discrimination in favor of higher salaried employees the plan itself could become disqualified by the IRS and all tax benefits would be eliminated.


Half what?

Over that last week I’ve had the chance to talk more in depth and think about the word perspective. In other words, how do we look at things? How do we see the world? Granted this may be pretty deep for a financial blog, however perspective is important when it comes to finances.

Here are few examples to ponder:

  • A millionaire does his or her best to legally reduce their tax bill and some would say that they are making too much money and should pay more in taxes. Looking at it differently the millionaire gave several hundreds of thousands of dollars away to charity (thus reducing their tax bill) and they are a philanthropist.
  • A person investing in the market watches it crash and liquidates their entire portfolio. Another investor sees this as the market trading at fire-sale prices and buys as much as they can – buying low, often from the investor selling low to liquidate.
  • A husband says that he doesn’t want or need life insurance because he doesn’t want his wife to be rich when he dies. Another husband buys as much as he can so his wife is financially secure when he’s gone.

These examples reflect the glass half-full/half-empty mentality. How we feel and respond to things is a direct reflection of how we perceive them. Sometimes we need to look at things differently to change our perspective. By looking at things differently, we open the doors for opportunity and can minimize loss.

Here’s a personal example. I love to garden. Some years ago I had planted a raspberry patch. Over time the canes spouted growth and started to throw off blossoms. For a period of about two weeks, I didn’t check on them and went out one day to see if there were any berries. To my dismay, there was gorgeous, lush green foliage but no sign of berries. I was disappointed. Dejected, I started walking away when something stopped me and I felt compelled to go back to the patch but look at it differently.

As silly as it was, I got down on my hands and knees and then laid on my back. I scooted under the leaves like a mechanic about to change oil in a car. My neighbors must have thought it was funny seeing only a lush green berry patch and feet sticking out! When I looked up all I saw was red! Berries everywhere!

By changing how I looked at things I went from dismay to over 3 gallons of berries. Imagine if I wouldn’t have looked – wasted berries (but happy rabbits).

So what are we wasting, missing out on, and losing by not changing our perspective?

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Mechanics of 401(k) Plans – Saving/Contributing

Image courtesy of Ppiboon at

Image courtesy of Ppiboon at

Many folks have a 401(k) plan or other similar Qualified Retirement Plan (QRP) available from their employer.  These plans have many names, including 403(b), 457, and other plans, but for clarity’s sake we’ll refer to them all as 401(k) plans in this article.  This sort of retirement savings plan can be very confusing if you’re unfamiliar, but it’s a relatively straightforward savings vehicle.

This is the first in a series of articles about the mechanics of your 401(k) plan – Saving/Contributing.


You are allowed to make contributions to the 401(k) plan, primarily in the form of pre-tax salary deferrals.  You fill out a form (online most of the time these days) to designate a particular portion of your salary to be deferred into the 401(k) plan.  Then, each payday you’ll see a deduction from your paycheck showing the 401(k) plan contribution.  The deduction is before income tax withholding is applied to the paycheck, since these contributions are “pre-tax”.  However, Social Security and Medicare taxes are applied to these deferrals.

Because of this pre-tax nature of your deferrals into the 401(k) plan, putting money in the plan will reduce your income taxes in the year of the deferral.  For example, if your income is $30,000 per year and you defer 5% of your income into the plan, your reported taxable wages would be 5% less, or $28,500.  As a result, your possible tax bill could reduce from $2,553.75 to $2,328.75, a reduction of $225. (This is an example only, using 2013 tax tables.)

Once your money is deferred into the plan you will be eligible to invest those funds as you see fit (we’ll get to the investments in a later post).

The deferred funds are your money.  You earned it, just the same as your take-home pay. The only way you lose this money is by investing in a security that loses money, such as a stock that goes bankrupt.  Otherwise, no one can take this money away from you.  When money is deferred to the plan you have an increase to the balance in your 401(k) plan just the same as your checking account increases with the direct-deposit of your take-home pay.

Roth 401(k)

Depending on your company’s plan, you may have a Roth 401(k) component available to you.  The mechanics are similar to the garden-variety traditional 401(k) plan – except that your contributions are post-tax, rather than pre-tax.  So the changes to your tax mentioned above do not apply to contribution made to a Roth 401(k) plan.  Then, when you take the money out of the Roth 401(k) account at retirement (as long as you’re at least age 59 1/2 years of age) there is no tax on those withdrawals.  We’ll provide more detail on withdrawals in a later post.

If you have a Roth 401(k) plan available to you, it is simply another component of the overall 401(k) plan.  You have a choice as to whether or not your deferrals to the plan are made to the traditional 401(k) plan or the Roth 401(k) plan, and you can contribute any amount (up to the maximum) to the combination of these two plans in the tax year.

Annual Maximum Contributions

Each year the IRS provides guidance about the maximum annual contribution that can be made to a 401(k) plan.  For 2014, this maximum contribution is $17,500, and if the employee-participant is over age 50, an additional $5,500 “catch-up” contribution can be made for the tax year.  This could be as much as 100% of your annual contribution, if you wish.

If you are employed by more than one employer, this annual limit applies across the board to all plans that you might contribute to collectively (with one exception, below).  So if you have a second job where you can contribute to a 401(k) plan in addition to your primary job, you can only contribute up to $17,500 in total to all plans for 2014 (plus the $5,500 catch-up if over age 50).


Earlier, I mentioned that we were referring to all QRPs as 401(k) plans because they are much the same.  One difference comes about with annual contributions: 457 plans have the same limit as 401(k) plans, but are not subject to the “collective” limit mentioned above.  So if your employer provides both a 457 plan and a 403(b) plan, for instance, you could defer up to double the annual maximum contribution to these two plans – $35,000 (plus $11,000 if over age 50) for 2014.

Trust, But Verify

TrustSince late 2012 I have had the honor to provide financial counseling to our service members generally going to different military installations to talk to soldiers and their families regarding financial issues such as buying a home, saving for retirement, reducing and eliminating debt, or simply creating a budget. On my very first assignment I ever did, I pulled up to the base entrance – a heavily fortified gate and entrance – and was asked to park my vehicle to the side while they ran my ID and searched my vehicle for any contraband. There’s something humbling yet cool about being searched by military police with automatic weapons.

Naturally, other than remnants of a snack left over from my kids or an empty water bottle there was no contraband and I was free to close my vehicle up and drive to where I would be working for the day. This common routine has gone on several times at the same installation particularly.

A few months ago, I pulled up to the gate and was greeted by a soldier whom I’ve come to know and recognize and vice versa. When I handed him my ID he said, “I know who you are, sir, and welcome back.” He then went on to say, “I’m sorry sir, but I’m going to have to ask you to pull your vehicle over, open the doors, hood, glove box, console, and please turn off your engine.” He continued, “I know you’ve been here many times, but we have to follow protocol.”

Naturally, I don’t argue and am more than happy to comply. I’ve built rapport and trust, but they still have to verify.

The same is true with your financial planner, insurance agent, advisor, or other professional. It doesn’t hurt to verify things they say or reports they give. I’m not saying to never trust them or be leery, but I am saying it’s ok to check up on their work, advice and numbers every so often.

For example, I’ll encourage clients to check me out independently of our website or what I’m saying. One of the first places I recommend is which is an excellent way to look at a financial advisor’s history, record and possible affiliations with other companies. If he or she is a CFP®, ChFC®, CLU®, etc., verification of their designations can be found at for the CFP® and for the ChFC® and CLU®.

Verifying numbers and returns can be a bit trickier, but certainly doable. It never hurts to investigate yourself or if you feel comfortable, getting a second opinion. Ask questions about gross versus net returns, fees, expenses, and compensation. Visiting is another great way to investigate recommended mutual funds, stocks, bonds and portfolio allocations.

Finally, it never hurts to trust your gut. If something sounds too good to be true it usually is. If something just doesn’t sound right, it’s probably wrong. If something doesn’t make sense to you, it probably doesn’t make sense. And if the advisor, agent, professional can’t explain how the product works or how they get paid – run.

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Book Review: Facing the Finish–A Roadmap for Aging Parents and Adult Children

facingthefinishOne of life’s only sureties, we all will eventually come face-to-face with the end of our life.  Sometimes it comes quickly with no warning, and sometimes end of life comes more slowly, over the course of many months or years.  In either case, after life there are many things to deal with (for those that remain) – and in the cases where the final chapter of our life is a lengthy one, there are many more decisions to make and situations to deal with. Regardless of how swiftly or drawn out the event is, we can all benefit from planning out many of the inevitable decisions in advance.

This book is an excellent guide for folks who are either nearing that final transition in life (referred to by the author as Older Adults), or who are helping our parents or grandparents with this transition (referred to as Adult Children).  Most everything that you need to consider about this transition is covered here, from decisions about your personal and financial affairs, involving your family in decision-making (where appropriate), decisions about care and housing, as well as how to finance your final chapter of life.

The book was written by Sheri L. Samotin, who is a life transitions coach, National Certified Guardian, and certified Professional Daily Money Manager and the founder of LifeBridge Solutions LLC.  Ms. Samotin brings her wealth of knowledge and experience in helping Older Adults and their Adult Children deal with the challenges of aging.  With these insights Samotin provides many real life examples to illustrate her points, which help to personalize the lessons.

I believe that all persons, whether Older Adults or Adult Children, can get a great deal of benefit from this book. The author brings to the fore many salient points that you might not otherwise have considered as you face this transition, from either point of view (Older Adult or Adult Child).  It’s a relatively short read (roughly 200 pages) and is written in an easy, conversational style (not full of technical jargon!).  I will recommend this book for clients in either situation who are looking for just such a roadmap (and even if they don’t know they’re looking for such a roadmap!).

Do I Need My Life Insurance Through Work?

Berry Hard Work

Berry Hard Work (Photo credit: JD Hancock)

Many employees have access to employer provided benefits such as health insurance, a retirement savings plan disability insurance and life insurance. Generally the coverage is group term coverage that will pay a specified death benefit up to a certain amount that is usually based on a multiple of the employee’s salary.

An employee making $50,000 per year may have group term life insurance that pays a death benefit of $40,000. Generally the employer will pay the premium for coverage up to a certain death benefit amount. Usually this amount is $50,000. The reason why is the IRS allows the employer to pay the premiums on a group life insurance policy up to a face amount of $50,000 without the employee having to include the amount the employer pays for premiums in gross income. Sometimes the employee can elect to have coverage for a higher amount but will most likely have to pay the difference between what the employer pays and the death benefit from that amount and the amount of the increase in the premiums paid for the extra death benefit.

For example, an employer may pay the premiums for the first $50,000 in death benefit but allows the employee to elect up to 5 times their salary for group term coverage. If the employee chooses 5 times their salary they will have a $250,000 death benefit.  The employee will pay the premium for the additional $200,000 in coverage.

So is employer sponsored life insurance a good deal? You bet it is! Generally this is the most insurance a person can get with almost no underwriting involved. This means a person in poor health or with a pre-existing condition may get coverage for pretty cheap. For many, this is the only insurance they can get due to health or affordability.

If you can, it makes sense to buy the most group term life insurance you can buy. Supplement any additional term insurance need with coverage from a reputable insurance company.

Some employer policies are portable which means that the coverage can be taken after the employee leaves their employer. This is usually done via conversion – the group term policy converts to an individual permanent policy such as whole life or universal life. Conversion can be done without having to go through underwriting, however the premiums will likely be sky high.

This can make sense if it’s the only insurance someone can get and they still have a need. If they can get an individual term policy, this is almost always the best way to go. They can get underwritten for any term length they need – 10, 20, or 30 years and the premiums will be based on underwriting and term length.

Another idea to consider is buying a large term policy individually and then supplementing the maximum you can get through your employer. That way you’ll always have you own policy regardless of what happens to your employment.

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Be Careful When Converting

Conversion of St Paul

Conversion of St Paul (Photo credit: Lawrence OP)

When converting from a 401(k), traditional IRA, 403(b), SIMPLE IRA, SEP or 457(b) to a Roth IRA there are some important tax considerations to keep in mind.

First, converting from a tax deferred plan to a tax free plan it’s not always the best idea. Generally, it’s going to make sense to convert if the tax payer believes that he or she will be in a higher income tax bracket in retirement. For example, John, age 28 has a 401(k) and recently left his employer. He’s currently in the 15% bracket but expects to be in the 28% bracket or higher in retirement. It may make sense for John to convert his 401(k) to his Roth IRA.

This makes sense for John because when he converts from a pre-tax, employer sponsored plan like the 401(k) it’s money that has not yet been taxed. If he converts while in the 15% bracket, that money is now subject to tax at the 15% rate, and arguably a lower amount of money being taxed since he’s still young. If he decided to wait until retirement to convert (let’s assume he’s in the 28% bracket) then that money is going to be taxed at 28%, or almost twice the rate if he had converted when he was in the 15% bracket. John has also eliminated future RMDs as Roth IRAs have no such requirement.

Generally, it may make sense to not convert if you expect to be in a lower tax bracket at retirement. The reason is you’d convert at a higher tax bracket today, only to be in a lower bracket in retirement. Thus, you’ve paid a higher than necessary amount of tax on your money.

Second, when converting, pay close attention to you your age and how you choose to “pay” the tax. Let’s look at two examples.

Let’s say John in the example above decides to convert when he leaves his employer at age 28. He’s saved a nice sum of $100,000 in his 401(k). He decides to convert to a Roth IRA at the 15% bracket. He elects to pay the tax himself from outside of the 401(k), that is, he elects to not have any tax withheld from the conversion. He decides he’ll pay the tax from another source when tax time comes around. All is being equal, John owes $15,000 at tax time.

This turns out to be a very wise decision for John. Here’s why.

Let’s assume the same scenario above except that John decides to have the $15,000 withheld from his 401(k) to pay the taxes on the conversion. Remember how old John was? 28. He’s under age 59 1/2 and the $15,000 withheld for taxes is considered an early distribution, and, you guessed it, subject to the 10% early withdrawal penalty. So instead of paying $15,000 in taxes, John pays an additional $1,500 due to the 10% penalty or a total of $16,500.

It pays (either you or the IRS) to consider the tax ramifications of converting to a Roth IRA. Talk to an experienced financial planner and or tax advisor for help.

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Tax Time is Over. Maybe.


For most folks tomorrow marks the one week anniversary of filing their 2014 tax return. Not much needs to be done after they’ve filed except for deciding to have more withheld in 2014 for those folks who had to write a check to Uncle Sam or deciding what to do with the refund (hint: put it in an IRA) for those folks who got a refund.

What happens when the return may have been submitted with mistakes or perhaps costly errors? Generally, if the error is minor the IRS will correct errors or accept returns without certain forms or schedules attached.

For those returns that have a change in filing status, income, deductions, and credits then filing an amended return will most likely be appropriate. For those folks needing to file an amended return they are allowed to file using form 1040X. Form 1040X will allowing corrections to earlier filed returns that used 1040A, 1040EZ.

If a person needs to file for separate years then a separate 1040X must be filed for each tax year that’s being amended.

According to IRS topic 308 keep the following points in mind:

  • Attach copies of any forms or schedules that are being changed as a result of the amendment, including any Form(s) W-2 received after the original return was filed.
  • Tax forms can beobtained by calling 800-829-3676 or visiting
  • An amended tax return cannot be filed electronically under the e-file system.
  • Normal processing time for Forms 1040X is up to 12 weeks from the IRS receipt date.

Generally if a refund is to be claimed the amended return needs to be filed within 3 years after the due date of your original return or 3 years after the date you filed your return if you filed for an extension.

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Do Unto Others?

anonymousIn the financial services industry there has been considerable discussion on the application of the fiduciary standard of care for clients versus the suitability standard of care. There are generally two sides to the argument: on the fiduciary side the standard of care is to act in the best interests of the client (the standard that Jim and I are held to and embrace) and the other side which is a suitability standard of care in which the recommendation needs to be suitable, but not necessarily in the best interest of the client.

This is where things get sticky.

Acting in the best interest of the client is pretty cut and dry. After extensive questioning and gathering of information a recommendation is made to the client based on what is best for their situation. This means recommending keeping the current course of action, following a designed and carefully thought out plan, or recommending the client do business elsewhere.

Suitability on the other hand requires only finding an appropriate solution that suits the client. This may be a proprietary product that the advisor is only able to sell based on company and contract affiliation, licensing and compensation structure. In other words (and these are my words only) the advisor rationalizes the reason for the recommendation whether or not it’s in the client’s best interest.

Proponents of the suitability standard are normally compensated by commissions only or a combination of commission and fees. They are normally adamant about only adhering to the suitability standard. Why? The answer is simple: self-preservation. Think of it this way, if the only way you’re compensated is through the sales of a product then why would you want to be held to a standard that says what you’re selling has to be in the best interest of the client? What if you can only sell life insurance or annuities? As the saying goes, if you all you have is a hammer then everything looks like a nail.

Proponents of the fiduciary standard are dominantly compensated by fees directly from the client. What does this mean? This means the client pays the advisor for their advice, not a product sale. The relationship nor the compensation of the advisor isn’t tied to a sale it’s tied to the quality of advice. In other words, it’s very transparent. The client knows exactly what they’re paying for and can rest assured they’re getting advice regardless of a product sale. In this case the advisor has a tool box full of tools to utilize instead of just one tool.

Admittedly this type of system is not 100% perfect. There will still be a few bad apples and there will always be outliers, and there will be bad advice. However, from personal experience I have been able to witness both sides. Early in my financial career I worked for a firm that was commission only – one of those firms where I was told if the client wasn’t going to buy, send them to the 800 number. Really. Temptation to sell something, anything to make a living was high. I was arguably the worst salesperson they had. It’s extremely difficult to be a fiduciary in that situation – not impossible, but difficult.

Being able to work with a firm that is aligned with my own beliefs embracing the fiduciary standard there is zero temptation to recommend anything less than what’s best for the client. No sales pressure, no product pushing.

For those that would argue against the fiduciary standard let me ask this question. It’s a question I ask ask frequently of my students and colleagues that argue in favor of suitability.

“If roles were reversed and you were the client, what standard would you want applied to you?”

They answer almost always the fiduciary standard. The next question is rhetorical, but apt:

“They why should your clients get anything less than what you want for yourself?”

There’s usually silence.

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Obamacare and Your 2013 Tax Return

Taxation - Highlighted in the dictionary

Taxation – Highlighted in the dictionary (Photo credit: efile989)

So – you’re considering your income tax return (or maybe you’ve already filed) and you’re wondering if there are things you need to know with regard to Obamacare.  Fortunately, it’s not much (for most folks), for your 2013 return anyhow.  Next year will be a different story.

The IRS recently produced their Health Care Tax Tip HCTT-2014-10 which lists some tips about how the health care law impacts your 2013 tax return.  The actual text of the Tip is below:

What do I need to know about the Health Care Law for my 2013 Tax Return?

For most people, the Affordable Care Act has no effect on their 2013 federal income tax return.  For example, you will not report health care coverage under the individual shared responsibility provision or claim the premium tax credit until you file your 2014 return in 2015.

However, for some people, a few provisions may affect your 2013 tax return, such as increases in the itemized medical deduction threshold, the additional Medicare tax and the net investment income tax.

Here are some additional tips:

Filing Requirement: If you do not have a tax filing requirement, you do not need to file a 2013 federal tax return to establish eligibility or qualify for financial assistance, including advance payments of the premium tax credit to purchase health insurance coverage through a Health Insurance Marketplace. Learn more at

W-2 Reporting of Employer Coverage:  The value of health care coverage reported by your employer in box 12 and identified by Code DD on your Form W-2 is not taxable.

Information available about other tax provisions in the health care law:  More information is available on regarding the following tax provisions: Premium Rebate for Medical Loss Ratio, Health Flexible Spending Arrangements, and Health Saving Accounts.

More Information

Find out more tax-related provisions of the health care law at

Find out more about the Health Insurance Marketplace at

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Avoiding Mistakes on Your Tax Return



When filing your tax return you want to make sure that you don’t make mistakes.  Mistakes can be costly in terms of additional tax and penalties, as well as the extra time and grief they can cause you.  Most of the time using e-filing software can help you to avoid these mistakes, but you should check over the return anyhow to make certain you haven’t fat-fingered something or if something didn’t go wrong with the software.

The IRS recently issued their Tax Tip 2014-46, which lists out 8 common mistakes that folks make on their tax return, and how to avoid them where possible.  The actual text of the Tip follows below:

Eight Common Tax Mistakes to Avoid

We all make mistakes.  But if you make a mistake on your tax return, the IRS may need to contact you to correct it.  That will delay your refund.

You can avoid most tax return errors by using IRS e-file.  People who do their taxes on paper are about 20 times more likely to make an error than e-filers.  IRS e-file is the most accurate way to file your tax return.

Here are eight common tax-filing errors to avoid:

  1. Wrong or missing Social Security numbers.  Be sure you enter all SSNs on your tax return exactly as they are on the Social Security cards.
  2. Wrong names.  Be sure that you spell the names of everyone on your tax return exactly as they are on the Social Security cards.
  3. Filing status errors.  Some people use the wrong filing status, such as Head of Household instead of Single.  The Interactive Tax Assistant on can help you choose the right one.  Tax software helps e-filers choose.
  4. Math mistakes.  Double-check your math.  For example, be careful when you add or subtract or figure items on a form or worksheet.  Tax preparation software does all the math for e-filers.
  5. Errors in figuring credits or deductions.  Many filers make mistakes figuring their Earned Income Credit, Child and Dependent Care Credit, and the standard deduction.  If you’re not e-filing, follow the instructions carefully when figuring credits and deductions.  For example, if you’re age 65 or older or blind, be sure you claim the correct, higher standard deduction.
  6. Wrong bank account numbers.  You should choose to get your refund by direct deposit.  But it’s important that you use the right bank and account numbers on your return.  The fastest and safest way to get a tax refund is to combine e-file with direct deposit.
  7. Forms not signed or dated.  An unsigned tax return is like an unsigned check – it’s not valid.  Remember that both spouses must sign a joint return.
  8. Electronic filing PIN errors.  When you e-file, you sign your return electronically with a Personal Identification Number.  If you know last year’s e-file PIN, you can use that.  If not, you’ll need to enter the Adjusted Gross Income from your originally-filed 2012 federal tax return.  Don’t use the AGI amount from an amended 2012 return or a 2012 return that the IRS corrected.
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