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Your Employer’s Retirement Plan

Mar 13th, 2013
by sraskie.
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Backcountry Provisions

Whether you work as a doctor, teacher, office administrator, attorney, or government employee chances are you have access to your employer’s retirement plan such as a 401(k), 403(b), 457, SEP, or SIMPLE. These plans are a great resource to save money into, and some employers will even pay you to participate!

Let’s start with the 401(k). A 401(k) is a savings plan that is started by your employer to encourage both owners of the business and employees to save for retirement. Depending on how much you want to save, you can choose to have a specific dollar amount or percentage of your gross pay directed to your 401(k) account. Your money in your account can be invested tax-deferred in stock or bond mutual funds, company stock (if you work for a publicly traded company), or even a money market account. Your choice of funds will depend on the company that offers the 401(k) through your employer. Generally, you’re going to want to choose funds with low fees and expenses. As of 2013, the maximum amount you can put into your 401(k) is $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older. At age 59 ½ qualified withdrawals are now taxed as ordinary income. Withdrawals before age 59 ½ are subject to penalties with some exceptions.

A cousin to the 401(k) is the 403(b). The 403(b) is very similar to the 401(k) in that you’re allowed to allocate a certain amount or percentage of your gross pay to your account, tax-deferred. Where the 403(b) differs is that it’s only allowed for non-profits such as school districts, hospitals, municipalities, and qualified charitable organizations. Another difference is by law the money in your 403(b) can only be invested in mutual funds or annuity contracts. You’re not allowed to own individual stocks or bonds in it. Like the 401(k), you’re allowed to save (as of 2013) $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older. At age 59 ½ qualified withdrawals are now taxed as ordinary income. Withdrawals before age 59 ½ are subject to penalties with some exceptions.

Branching out in our retirement plan family tree we come to the 457 plan. 457 plans are reserved for certain non-profits such as hospitals, government entities, school districts and colleges and universities. As you may have guessed, 457 plans are similar to their 401(k) and 403(b) counterparts in that money from your gross pay goes into your account tax-deferred. Like the 403(b) the 457 only allows investments in mutual funds or annuity contracts.

Similar to the 401(k) and 403(b), you’re allowed to save up to $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older (for 2013). Unlike the 401(k) and 403(b) the 457 allows you access to your money at any age, as long as you’re separated from service from your employer. For example, if you were 40 years old and have been saving into a 457 since you were age 25 and you saved $50,000 and you were fired, laid off or resigned, you’d have access to your 457 money without penalty; you’d simply pay ordinary income tax on any withdrawals.

Another key point to make is in regards to the aggregation rule. What this means is that you’re only allowed to invest $17,500 (along with the “catch-up” if you qualify) total between a 401(k) and a 403(b). For example, you work as a professor for nine months of the year and save $14,000 in your college’s 403(b). Over the summer, you work part time for a company that offers a 401(k) plan and you want to save money there. Assuming you’re age 40, you’d only be able to save an additional $3,500 to your summer company’s 401(k) – for a total of $17,500.

There is one exception to the aggregation rule. If you have access to a 401(k) or 403(b) and a 457, you are allowed to contribute the maximum to the 401(k) or 403(b) – for a total of $17,500 and then contribute the maximum to the 457 for an annual total of $35,000. The 457 trumps the aggregation rule. Few people may be able to actually sock away $35,000 per year, but it is available to those that work for employers offering both plans or if you work for two or more employers and they offer one or the other.

SEPs and SIMPLEs work a bit different. Typically these plans are available to smaller employers and SEPs are common for those that are self-employed. Both SEPs and SIMPLEs use IRAs as the funding vehicle to place retirement money, but each has different requirements as to contribution limits and participation requirements.

SEPs (Simplified Employee Pensions) can be funded to a maximum of $51,000 annually (for 2013) or 25% of the employee’s salary – whichever is smaller. There can be corresponding tax deductions involved that may be beneficial for solo businesses or businesses with a small number of employees as there are requirements that all employees must participate.

SIMPLEs (Savings Incentive Match PLan for Employees) are another option for smaller businesses looking to start a retirement plan and looking for a cost effective way to start (a 401(k) can be administratively expensive). Essentially, both employer and employees are allowed to participate and certain rules dictate that the employer must make a matching contribution (hence the Match in the name) to participating employees. As of 2013 you can contribute a maximum of $12,000 annually to a SIMPLE plan with an additional “catch-up” contribution of $2,500 if you’re age 50 or older.

The aggregation rule that applies to the 401(k) and 403(b) also applies to SEPs and SIMPLEs. This means that of the four plans for 2013, you’re still only allowed a total contribution of $17,500 annually ($23,000 if you’re age 50 or over). Having a 457 would be the only way to increase this amount.

Like SEPs and SIMPLEs, some 401(k) and 403(b) plans also have the company match. This means that in addition to your contributions, your employer will also make a contribution or “match” to the amount you’re contributing up to a certain percent. Consider taking full advantage of this. It’s free money! There are several reasons why an employer would do this ranging from plan compliance to helping ensure employee satisfaction and loyalty.

Finally, participating in your employer’s plan does not prohibit you from participating in a Traditional or Roth IRA. You are allowed to contribute the maximum allowed by law to both your employer’s plan and your own IRA.

It goes without saying that before you decide to participate, talk with your human resources department (not your cubicle buddy) or a financial professional regarding your options and which option or combination is right for you.

How Dollar-Cost-Averaging Can Work to Your Advantage for Your 401(k)

Feb 6th, 2013
by jblankenship.
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Average Afternoon on Highway 401

When you invest in your 401(k) plan with salary deferrals from each and every paycheck, you are taking part in a process known as Dollar-Cost-Averaging (DCA).  This process can be advantageous when investing periodically over a long span of time, by smoothing out the volatility of the market and giving you an average cost of your investment shares over time.

How does this work, and how can it be advantageous?

Dollar-Cost-Averaging

When deferring income with each paycheck, typically you will be investing in your 401(k) plan each pay period, whether monthly, bi-weekly, or weekly.  Each pay period the same amount is deferred and invested, no matter what the price of the underlying investments are at the time.  Since you’re always putting the same amount into the investment, when the price of the shares is higher, you purchase fewer shares; when the price is lower, you are purchasing more shares.

Note: DCA can be used with any type of investment account, including a 401(k), 403(b), IRA, or even a non-tax-deferred investment account.  We’ll refer to 401(k) accounts throughout the article since this is one of the more common accounts where DCA is employed.

For example, let’s say that you defer $100 every two weeks into your 401(k) plan, and your investment is an index fund.  For the first pay period the price of the fund is $10.  When you make your deferral and purchase this time, your $100 purchases 10 shares.

Then, in the next pay period the price of the shares of your index fund has increased to $10.50.  Now your $100 purchases 9.5238 shares, and you have a total of 19.5238 shares, at a price of $10.50 per share, for a total account value of $205.

On the following pay period the price of your index fund has fallen to $9.50 per share.  Your $100 deferred will purchase 10.5263 shares of the fund – you now have a total of 30.0501 shares at a price of $9.50, with a total account value of $285.48.

The table below plays out purchases with random amounts over a year and then tallies the result:

Pay Period Amount Deferred Price Per Share
 Shares Purchased
 Total Shares Total Value
1 $100 $10.55 9.4787 9.4787 $100.00
2 $100 $10.44 9.5785 19.0572 $198.96
3 $100 $9.92 10.0806 29.1378 $289.05
4 $100 $10.33 9.6805 38.8183 $400.99
5 $100 $11.95 8.3682 47.1865 $563.88
6 $100 $11.36 8.8028 55.9893 $636.04
7 $100 $9.14 10.9409 66.9302 $611.74
8 $100 $9.54 10.4822 77.4124 $738.51
9 $100 $11.67 8.569 85.9814 $1003.40
10 $100 $9.76 10.2459 96.2273 $939.18
11 $100 $10.46 9.5602 105.7875 $1106.54
12 $100 $9.62 10.395 116.1825 $1117.68
13 $100 $10.23 9.7752 125.9577 $1288.55
14 $100 $10.70 9.3458 135.3035 $1447.75
15 $100 $10.40 9.6154 144.9189 $1507.16
16 $100 $11.52 8.6806 153.5995 $1769.47
17 $100 $11.37 8.7951 162.3946 $1846.43
18 $100 $10.91 9.1659 171.5605 $1871.73
19 $100 $11.55 8.658 180.2185 $2081.52
20 $100 $10.37 9.6432 189.8617 $1968.87
21 $100 $10.19 9.8135 199.6752 $2034.69
22 $100 $9.98 10.02 209.6952 $2092.76
23 $100 $11.89 8.4104 218.1056 $2593.28
24 $100 $11.82 8.4602 226.5658 $2678.01
25 $100 $10.33 9.6805 236.2463 $2440.42
26 $100 $11.41 8.7642 245.0105 $2795.57

The table above was created by generating random prices between $9 and $11.99 over the 26 periods. In real life, your investment wouldn’t likely have such wildly-fluctuating values during the course of 26 pay periods – I used this degree of fluctuation to demonstrate the benefit of DCA when the investment is relatively volatile.

The Advantage

If, instead of investing $100 every two weeks you saved up the entire $2600 and invested it at the end of the 26th pay period, you would be purchasing all of the shares at $11.41, for a total of 227.8703 shares.  By DCA, your $2600 has increased in value such that you hold 245.0105 shares, with a value of $2795.57 – a net benefit of $195.57.

On the other hand, if you had $2600 to invest at the beginning of the table when the price was $10.55 per share, you would have purchased a total of 246.4455 shares, which would be worth a total of $2811.94 at the end of the 26 periods.

You can see from the table that by Dollar-Cost-Averaging, you achieve an average price per share over the period that is beneficial to you – since you’re purchasing exactly the same dollar amount of shares every time.  When the price is high, you buy fewer shares, and when the price is low you buy more shares.  By doing this over a long period of time, such as 30 years, you will avoid the risk associated with saving up a large sum of money and (perhaps) purchasing shares in an investment at a relatively high price by comparison over the savings period.

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Join in the Movement – Add 1% to Your Savings This Year!

Nov 28th, 2012
by jblankenship.
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Retirement

Over the past several weeks we’ve been writing articles to encourage all Americans to add at least 1% more to savings in the coming year. More than 20 of my fellow bloggers have submitted articles, and these articles include many great ideas that you can apply in order to increase your savings rate in the coming year.

Since many employees are going through annual benefit elections right about now, it’s a very good time to increase your annual contributions to your retirement savings plans. Big changes are easiest to undertake with incremental steps – starting with adding 1% can have a great impact and get the momentum going!

Listed below are all of the articles that I’ve been notified about so far – 22 23 in all! These folks are very smart, and have shared some great ideas. You owe it to yourself to check it out, and then take action!  Add that 1% to your 401(k) or IRA!  If you’re a blogger, see the original post for details on how to join the action: Calling All Bloggers!

Listed below are the articles in our movement so far (newest are at the top):

A video tv segment from Laura Scharr: Preparing for Retirement

From Paula Hogan: 6 Ways to Add Another 1% of Income to Retirement Savings in 2013

From Kevin O’Reilly: From TwentySomething to Millionaire

From Tom Batterman: Take the 1% Challenge in 2013!!!

From Dana Anspach: Can You Spare A Penny?

From Steve Doster: The Easy Way to Become a Millionaire

From Nancy Anderson: Save 1% More for Retirement in 2013

From Kathy Stearns: Do the 1% in 2013!

From Ken Weingarten: The 1% Challenge (Should you dare to accept)

From Richard Feight: The 1% Challenge!

From John Hunter: Save What You Can, Increase Savings as You Can Do So

From Emily Guy Birken: Increase your savings rate by 1%

From Jonathan White: Ways to increase your retirement contributions 1% in 2013

From Alan Moore: Financial Challenge – Should You Choose To Accept It

From Ann Minnium: Gifts That Matter

From Laura Scharr: In Crisis: Personal Savings- Here Are Six Steps to Improve Your Retirement Security

From yours truly: Add Your First 1% to Your 401(k)

From Steve Stewart: Seriously. What’s 1 percent gonna do?

From Theresa Chen Wan: Saving for Retirement: The 1% Challenge for 2013

From Mike Piper: Investing Blog Roundup: Saving 1% More

From Robert Wasilewski: Increase Savings Rate By 1%

From Sterling Raskie: A Nifty Little Trick to Increase Savings

From Roger Wohlner: Need Post-Election Financial Advice? Try the 1% Solution

From Michele Clark: Employer Retirement Accounts: 2013 Contribution Limits

Thanks to all who have participated so far – and keep those links coming!

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Converting an Inherited 401(k) to Roth

Nov 30th, 2011
by jblankenship.
2 comments
Lillian Roth
Image via Wikipedia

One of the provisions that is available to the individual who inherits a 401(k) or other Qualified Retirement Plan (QRP) is the ability to convert the fund to a Roth IRA.

This gives the beneficiary of the original QRP the option of having all of the tax paid up front on the account, and then all growth in the account in the future is tax free, as with all Roth IRA accounts.

What’s a bit different about this kind of conversion is that, since it came from an inherited account, the beneficiary must take distribution of the account over his or her lifetime, according to the single life table.  This means that, in order for this maneuver to be beneficial, the heir should be relatively young, such that there will be time for a lengthy growth period for the account – making the tax-free nature of the Roth account worthwhile.

A downside to this move is that the heir should be in a position to pay the tax on the account from other funds, otherwise the tax pulled from the account will drastically reduce the funds that can grow over time.

If the heir has an IRA of his or her own that could be converted, and there are only enough other funds for paying tax to enable the conversion of one account or the other, the IRA should be converted rather than the QRP.  This is because the IRA has a much better chance for long-term growth than the inherited QRP due to the requirement for distribution of the account (as discussed above).

This is yet another reason that an individual might want to leave funds in a 401(k) plan rather than rolling it over to an IRA – since the heir does not have this Roth conversion option available if the money is in a traditional IRA.  This option is only available for an inherited 401(k) or QRP.

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Required Minimum Distributions for IRAs and 401(k)s

Mar 23rd, 2011
by jblankenship.
1 comment

This is one of those subjects that can be a bit confusing – and it’s based on the rules that apply to the different kinds of plans.  You are aware that you’re required* to begin taking Required Minimum Distributions (RMDs) once you reach age 70½ – but did you know that specifically which account you take the RMD from has some flexibility?  Well – not just flexibility, also some rigidity…

You Alone amongst all the Thousands....... m...
Image by -RejiK via Flickr

There is a Difference Between IRA and 401(k)

Starting off, we need to understand that, in the IRS’s eyes, there is a big difference between an IRA and a 401(k).  For brevity, we’re referring to all sorts of Qualified Retirement Plans, such as 403(b) or 457 plans, as 401(k) plans. You may consider the two things to be more or less equal, but if you think about it, there are considerable differences between the two – amounts you can fund the account with each year, catch-up arrangements, who can defer funds into each kind of plan, and the list goes on.

A 401(k) plan, being an employer-provided retirement plan, has a completely different set of rules governing it – including provisions that go all the way back to the original ERISA legislation.  Among those rules are the rules about RMDs.

On the other hand, the IRA is not covered by ERISA, and as such there are other rules that apply to these arrangements – including the RMDs.

We don’t have nearly enough space here to go over everything that is different between these two types of plans, but we’ll cover the RMD treatment fairly well.

Required Minimum Distributions (RMD)

Each and every 401(k) plan that you own is treated as a separate account in the eyes of the IRS.  As such, if you have four old 401(k) plans when you reach age 70½, you will have to calculate and take a separate RMD from each 401(k) plan that you have.  In other words, you couldn’t aggregate all the plans together and take one RMD from one of the accounts that is large enough to cover all the RMDs.  In addition, you have to consider each account separately and figure out how much of each RMD is taxable, if you have post-tax dollars in the account(s).

However, no matter how many IRAs that you have, since the IRS looks at these plans as one single plan, you are allowed to pool all of the account balances together, calculate the RMD amount, and then withdraw that amount any single IRA account or any combination of accounts.  Your tax basis is aggregated as well, so the tax treatment is a consideration for the entire pool of your IRAs in total (rather than account by account as is the case with 401(k) plans).

Example

You have two old 401(k) plans and three IRAs.  This is your year, you’ve reached age 70½, so you have to start taking RMDs.  How do you do it for these five accounts?

Each 401(k) plan has to be calculated separately – and a RMD taken directly from each account.  But you can pool the IRA account balances together and take one RMD from one of the accounts that is large enough to cover all three accounts’ minimum distribution.

This is another reason why it can be helpful (from a paperwork standpoint, if nothing else) to rollover your old 401(k) plans into IRAs.  By doing this, you don’t have to take a distribution from, in the case of the example above, three different accounts at a minimum.

* One final note: if you are still working at and after age 70½ and your 401(k) plan allows it, you may not be required to take RMDs from the account.  This is yet another difference between IRAs and 401(k)s with regard to distributions.

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Paying Off Your Debts Using 401(k)

Aug 9th, 2010
by jreed.
2 comments

lets go by HeadOvMetal Note from Jim:  I’m on vacation this week, and in my absence I’ve had a few folks volunteer articles.  This is a guest post by Jack Reed. He offers advice on various debt related issues with special focus on bankruptcy.

Being in debt can be extremely stressful. Thousands of Americans are resorting to debt settlement services to reduce their debt burden. If you think that your debts are a major hindrance to securing financing for major purchases, then you might consider reducing your debt load by borrowing against your 401k. More and more people are looking at their 401k as an option to get out of debt. The best advantage that you get by doing this is that 401k loans are not normally reported to credit bureaus. Read on to know how you can go about it.

1) Approach your employer: First of all, you need to make sure whether you qualify for the loan. Read carefully the 401k plan description that you have with your employer. There are different types of plans; some allow you to take the loan while some will require you to pay a certain amount. Go through these plans to check your possibility of getting a loan against the money in your 401k.

2) Borrow only as much as you need: Withdraw just as much as you need to pay off your debt. Some plans might restrict you to take out just one loan at a time and you will not be allowed to use your 401k fund until you clear your first loan completely. If you are under 59½ years of age, then withdrawing from your retirement savings plan will invite penalties. Though you can evade these penalties, you may be required to draw money in annual installments and that will not be beneficial if you intend to make monthly payments on your debts.

3) Do the necessary paperwork: Ask your employer to provide you with the required paperwork and fill it up. You also have an option of logging into your 401k account online. After your loan gets authorized, you should receive a check in your mail from your plan account as a confirmation. Now you can pay off your debts using this money.

4) Repay the loan: Make a determination to replenish your 401k account if you have taken money directly from the plan. If you have borrowed money from your employer, then he normally adjusts by deducting money from your salary accordingly. If you fail to replace what you took, you will owe income tax on the money borrowed plus incur a 10% penalty if you are not at least 59½ years old.

5) Hardship withdrawals: Some plans permit you to withdraw funds if you are under financial hardship. But remember, once you take the money out of your plan using a hardship withdrawal, you can’t put it back in and you lose the tax advantage on those funds forever.

Your decision to use 401k money to pay off your debts is completely a personal issue. There are mixed reactions to it. Some advise against it while others who have benefited from it will encourage you. Remember that the purpose of your 401k plan is to provide for you in your golden years and being careful with your decisions will ensure that you do not compromise with your post-retirement happiness.

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