Maxing out your 401K too early every year can cost you over a million dollars!

Your 401K is often your biggest retirement nest egg, and maxing it out is a fantastic way to boost your retirement savings, however many people make very costly mistakes when trying to save for retirement.

The mistake that we will discuss today primarily affects people who have very good income, as well as good 401K match programs from their employers.  In my example, Mr. X will make $120,000/year salary, and he is going to get a $40,000 bonus in 2014, for a total 2014 income of $160,000, and his company matches 7% on his 401K contributions.  Mr. X always tries to max out his 401K as early in the year as possible, so that he can enjoy larger paychecks at the end of the year (because once you hit the 401K maximum, your total net pay goes way up due to that deduction stopping in your monthly paychecks).  In 2014, Mr. X decides that he will put 25% of his April bonus into the 401K and 15% of each paycheck into his 401K until he hits the maximum contribution level ($17,500/year).

After 5 months, Mr. X has invested $17,500 into his 401K, maxing out his annual contribution, and he enjoys much higher take-home pay for the next 7 months.

Congratulations Mr. X, you just cost yourself almost $5,000 in free money…

In a more severe example, where Mr. X makes $180,000/year salary, and gets a $70,000 bonus, he would have cost himself over $9,000 in free money…

How does this happen?

Well, in this case, Mr. X’s company matches the first 7% that he contributes from each paycheck.  However, his company no longer has to match once he hits the maximum contribution, therefore when he hit his maximum contribution after 5 months (in the first scenario), the company matched the first 7% of those 5 paychecks (and the bonus), but the company did not match anything in the last 7 months of the year.  Had he just put in 11% of his paychecks and bonus, instead of front-loading the contributions, he would have received an additional $4,900 in company contributions.  In the more severe example, let’s say that Mr. X lost $9,000/year in free money for 10 straight years between age 35 and 44, his 401K would end up being over $1,000,000 lower as a result when he retires.  So, we are not talking about chump change here…

The moral of this story is that maxing out your 401K is good, but maxing out your company contribution is even more important.  Your company is offering you (and your family) free money, so please make sure to spend a few extra minutes this year determining what percentage you should contribute so that you maximize your company’s match each month, and on your annual bonus, while hitting the maximum contribution at the very end of the year.  Your kids, and grandkids, will thank you for the extra million dollars decades from now…

 

NOTE:  Some companies DO provide catch-up contributions in these situations.  These rules are company and plan-specific, so it is always good to either check with the 401K provider, or check your final paycheck of the year to confirm that you got the catch-up contribution before assuming that you did.  It is worth noting that companies can change providers, or rules inside the 401K, at will. So, my advice would be to check the status of that rule each year prior to setting up your contribution strategy for the year.

Should You Consider Refinancing Your Mortgage Before Retirement?

Should You Consider Refinancing Your Mortgage Before Retirement?

This is a question that is almost never asked during retirement planning, but it definitely should be. For many of us, we will not ever pay off our home in full, nor are we willing to downsize due to our ego and/or our unwillingness to give up the lifestyle we have come accustomed to throughout our working years. For those of us in those scenarios, we should be looking at what the right time is to refinance shortly before retirement. For example, if you are currently in the 5th year of a 15-year mortgage, you may be paying $2,000/month. If you retired right then, that would be your payment for the next 8 years while you have a severely-reduced income. On the other hand, if you were to go and refinance your mortgage into a 30-year mortgage right before retirement, you might lower your payment to $1,200/month. While you would be paying longer, you would free up $800/month in cash flow during retirement. This will, again, give you much more financial flexibility during retirement. In addition, you will still be gaining equity in your home as you make the payments, so you will likely be able to sell the house in the future if you need to resort to downsizing. More importantly, if you refinance, you can continue to pay the $2,000/month if you want to, and pay off your mortgage just as fast as you would have in your current scenario. The best part about the refinance option is that if something goes terribly wrong, or something unexpected happens, you can immediately lower your payment from the inflated $2,000/month down to the required $1,200/month. If you were to try to do that under your old arrangement, you would be foreclosed on almost instantly. In addition, if you were to try to refinance your mortgage during retirement right after something unexpected happened, when you have little or no income, you are very unlikely to get approved for a loan. The bottom line is that refinancing gives you more flexibility, more cash flow, protects you from unexpected surprises, and still allows you to pay off your mortgage just as fast if you decide to continue to make the $2,000/month payment. Please consider this option in the few years before you retire.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

Should I Invest In My Own Company’s Stock?

Should I Invest In My Own Company’s Stock?

You will get many different answers on this question from your friends and co-workers. Here is the bottom-line: You already have an enormous portion of your retirement linked to your current employer. Your income, and future income, are all linked to your current employer’s well-being. Think, for a moment, what would happen if your company went out of business. You would instantly lose your income, your future income, along with any stock options you held at the company. Isn’t that enough of an investment? Now, if someone were to have 50% of their 401K in their own company’s stock, they would also lose 50% of their retirement nest egg immediately. In my personal opinion, you have enough invested in your own company the day you begin working there, so you should not invest in your own company within your 401K.

NOTE: The one exception, that I would make sure to point out, is when you are offered a match on your company’s stock (and not on other investments), or when you have an opportunity to purchase the company’s stock at a discount to the current stock price. In these unique scenarios, it makes a lot of sense to temporarily hold your company’s stock for the duration required to obtain the benefit.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

Should I Pay Off My Mortgage Before Retirement?

Should I Pay Off My Mortgage Before Retirement?

This is a question that is frequently asked during retirement planning sessions. All of our parents believed that it was important to retire without a house payment. Certainly, not having a house payment makes retirement much easier, but one must be very careful about how much they are willing to spend to make that happen. Becoming “House Poor” is a very real concern. This is a term that describes someone who puts all of their money into their home, and has no cash savings outside of the home to utilize. The reason this is a bad thing is that if you are retired and you own a $300,000 home that is completely paid off, but you have no savings, it is nearly impossible for you to access the equity in your home. It is hard to get a loan if you don’t have significant income, and while their are certain mortgage tools you can use to extract value from your home, this is not an ideal situation to be in. Becoming “House Poor” is something that you definitely want to avoid during retirement. If you read between the lines, I am basically saying that you should not pay off your house while neglecting your other retirement accounts (such as your 401K or IRA accounts). If you can afford to build up your retirement accounts and pay down your mortgage, then this can be an excellent strategy. If you can afford to do only one of these, please focus on building your retirement nest egg. You can always pay off your house with the money later, and you will have much more flexibility in your future finances. Not to mention, you will continue to get years of tax-deductible mortgage interest, tax-deductible 401K contributions, and tax-deferred 401K growth. When you add all of this up, you will be very glad that you took this advice.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

What Is A Roth IRA?

What Is A Roth IRA?

This type of account has contribution limits (under the 2010 rules, you could invest $5K/year if you are 49 or younger, and $6K/year if you are 50 or over). This type of account also has income limits, so you should check to see if you make too much money to qualify (2010 limits ranged between $105K – $120K for single filers, and between $167K – 177K for joint filers, meaning that if you made less money than the low-end of the range you could invest fully in the account, and if you fall somewhere in the range you may be able to invest a portion of the limits into the account).

There are two main differences between the Roth IRA and the Traditional IRA: The Roth IRA grows Tax-Free, and the contributions are not Tax-Deductible. Tax-Free means is that if your $3,000 contribution grew at 10% for 20 years, you would then have just over $20,000 without ever paying a dime of taxes. You will then not be taxed at all on the income when you withdraw the money during retirement. By not paying taxes throughout your working years, the money accumulates much quicker, and your retirement pot grows more rapidly. By not paying taxes when you withdraw the money, you save an enormous amount of money during retirement. Since the contributions are not Tax Deductible, this means that if you put in $3,000 dollars, you will not be able to write off any tax dollars for the current tax year.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

Can Life Insurance Be A Suitable Retirement Investment?

Can Life Insurance Be A Suitable Retirement Investment?

If you have a lot of money, and you are looking for a way to lower your lifelong tax exposure, then Life Insurance could be a unique tool for you to use during your retirement planning. I will not get deep into the strategies in this article, but I will tell you that I have seen clients save hundreds of thousands of dollars in taxes using life insurance vehicles such as a Variable Universal Life policy as a retirement vehicle. These are only suitable investments for people who have a lot of discretionary income, a higher tolerance for risk, and are in relatively good health at the time of the initial investment. Essentially, you take out a life insurance policy for $1,000,000. You begin putting in a certain amount of money a month, let’s say $1,500 (though there are limits based on your age and the policy amount). Of this $18,000 you are investing each year, a portion will go towards paying for the life insurance that you have purchased, and another portion will go towards purchasing mutual funds on the inside of the life insurance policy. For this example, we will say that $10,000 goes towards your investments, and $8,000 goes towards insurance (but these numbers are fictitious and are only being used as an example). As you accumulate money in the inside of the policy, your insurance burden becomes less. For example, once you have $100,000 in the account, you are now only paying for $900,000 in life insurance (your original $1,000,000 minus the amount that is your money). Therefore, your $18,000 might look more like you putting $11,000 into the internal account, and only $7,000 into the insurance vehicle. As you can see, the more money that you accumulate on the inside, the less you pay for the insurance, and the more that goes into the internal account with each contribution.

Some of you may be wondering why this sounds like a good investment, but let’s play this out. The money inside of the internal account grows tax-free, and can be pulled out tax-free (provided you meet certain requirements to keep the policy considered as an insurance policy). So, this is one of the few investment vehicles where you can put several thousand dollars into it, growing tax-free, no matter how much money you make. For example, you could potentially stock away $100,000 a year which would then grow tax free if you purchase a large enough policy. The other upside, though slightly morbid, is that if you were to pass away early in the investment, your family would get the amount of the policy. For example, in the $1,000,000 policy we noted earlier, if you passed away ten years into the policy, you would have paid $180,000, and your family would receive $1,000,000. It wouldn’t make up for the severe loss your family has suffered, but it is a benefit that a simple IRA would not have afforded you.

These are extremely complex tax-advantaged vehicles, and you should consult a financial advisor before making final decisions on whether these are right for you. They are meant only for people with considerable means who are looking for both estate planning and retirement planning vehicles.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

What Is A Traditional IRA?

What Is A Traditional IRA?

This type of account has contribution limits (under the 2010 rules, you could invest $5K/year if you are 49 or younger, and $6K/year if you are 50 or over). This type of account also has income limits, so you should check to see if you make too much money to qualify (2010 limits ranged between $56K – $66K for single filers, and between $167K – 177K for joint filers, meaning that if you made less money than the low-end of the range you could invest fully in the account, and if you fall somewhere in the range you may be able to invest a portion of the limits into the account).

There are two major benefits of this type of account: Tax-Deferred Gains, and the contributions are Tax-Deductible. Tax-Deferred means is that if your $3,000 contribution grew at 10% for 20 years, you would then have just over $20,000 without ever paying a dime of taxes. You will only be taxed on the income when you withdraw the money during retirement. By not paying taxes throughout your working years, the money accumulates much quicker, and your retirement pot grows more rapidly. Tax Deductible contributions mean that if you put in $3,000 dollars, you will actually get to write off $3,000 off of your taxable income for the current tax year. For example, if you are in the 15% tax bracket, you would owe approximately $450 less in taxes if you made a $3,000 contribution. Between these two advantages, this account is generally a great match for anyone who qualifies for this account.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

How Should You Pick Your 401K Investments?

How Should You Pick Your 401K Investments?

First, I will state unequivocally, there is no easy 1-page answer to this question. That being said, In this article, I will do my best to give you the tools you need to make the proper choices in your 401K.

Should I Invest In My Company?

You will get many different answers on this question from your friends and co-workers. Here is the bottom-line: You already have an enormous portion of your retirement linked to your current employer. Your income, and future income, are all linked to your current employer’s well-being. Think, for a moment, what would happen if your company went out of business. You would instantly lose your income, your future income, along with any stock options you held at the company. Isn’t that enough of an investment? Now, if someone were to have 50% of their 401K in their own company’s stock, they would also lose 50% of their retirement nest egg immediately. In my personal opinion, you have enough invested in your own company the day you begin working there, so you should not invest in your own company within your 401K.

NOTE: The one exception, that I would make sure to point out, is when you are offered a match on your company’s stock (and not on other investments), or when you have an opportunity to purchase the company’s stock at a discount to the current stock price. In these unique scenarios, it makes a lot of sense to temporarily hold your company’s stock for the duration required to obtain the benefit.

What Mutual Funds Should I Pick?

Again, this is not a one-size-fits-all kind of question. I will say that there are a variety of 401K plans that offer “Funds-of-Funds”. A few examples of funds like this are “Fidelity Freedom 2040” or “Vanguard Target Retirement 2025”. Basically, these funds hold a variety of other mutual funds on the inside. Their aim is to put together a balanced portfolio with the goal of retiring in the year that is stated. For example, the “Vanguard Target Retirement 2025” fund is for people who are aiming to retire in, or around, the year 2025. It will be comprised of a more conservative investment portfolio than the “Vanguard Target Retirement 2045” Fund. This is because as you grow older, you should slowly make your retirement fund more conservative to protect against large swings in the stock market. These funds will actually slowly rebalance their holdings in order to slowly get more and more conservative as you approach retirement. I am a huge fan of these funds for the average 401K investor. If you choose this route, you will probably want to invest 100% of your portfolio in one of these funds. Most of you probably have been told to never, ever invest “all of your eggs in one basket”. The difference here is that each of these funds holds approximately 10 mutual funds (or thousands of total stocks), so you are probably more diversified than you would be if you were to assemble your own portfolio.

If you would much rather construct your own portfolio, then you should diversify your portfolio according to your risk tolerance. Regardless of your asset class, you should invest a percentage of your 401K across all asset classes, including Large-Cap, Mid-Cap, Small-Cap, International, and Bonds. I am going to give very broad-based guidelines here so that you can begin to construct your own portfolio if you wish. I am going to split the suggestions into 5 age groups and risk tolerances. Please note that the age groups and risk tolerances do not necessarily fit together (as some people are more or less risky than others), but you should choose either the age bracket, or risk tolerance to make your decisions.

Aggressive Portfolio – Typical Age Range: 18 – 35
25% Small-Cap, 25% Mid-Cap, 35% International, 15% Large-Cap, 0% Bonds

Moderately Aggressive Portfolio – Typical Age Range: 35 – 45
15% Small-Cap, 15% Mid-Cap, 20% International, 30% Large-Cap, 20% Bonds

Moderately Conservative Portfolio – Typical Age Range: 45 – 55
10% Small-Cap, 10% Mid-Cap, 10% International, 40% Large-Cap, 30% Bonds

Conservative Portfolio – Typical Age Range: 55+
5% Small-Cap, 5% Mid-Cap, 5% International, 40% Large-Cap, 45% Bonds

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

How Much Should I Put In My 401K?

How Much Should I Put In My 401K?

In general, you shouldn’t ever invest more than you can afford into your 401K. This money is meant to be kept in your retirement fund until after you retire (or at least 59 in most cases). There are instances where you can get to this money early, but they will generally include either taking a loan from yourself (and paying it back with interest), or paying a penalty and taxes on the money in order to withdraw the dollars early.

Why Put Money In At All Then?

401Ks are both Tax-Deductible and they grow Tax-Deferred. This means that you are able to write off the money that you put into your 401K. For example, if you make $100,000 a year and you put 15% away into your 401K, you would only pay taxes on $85,000. Basically, you would have put $15,000 into your retirement account, and you would have saved $4,200 (assuming you were in the 28% tax bracket). This $15,000 would then grow tax-deferred until you withdrew the money during retirement. If you never put another dollar into the 401K, that $15,000 would grow to over $100,000 if it grew at 10% a year over the next 20 years. At that point, you would have paid no taxes on the $85,000 of gains, and you would have saved $4,200 in taxes 20 years ago. Between those two benefits, you would have made a lot more money than if you had put $15,000 in a taxable non-retirement account, and you would not have had any tax benefit in that scenario. As you can imagine, if you put in 15% every year, you would save tens of thousands of dollars in taxes throughout the years, as well as benefitted from huge tax-deferred gains. You would have to pay taxes as you begin to withdraw these funds during retirement, but the common thought is that your tax bracket will be lower in retirement than it is while you are working. If you believe that will be true, and you can afford to invest the money, then you should almost certainly be investing in your 401K.

How Much Should I Put In?

The first thing to note here is that many companies offer a corporate match. Many of these matches will give you X% of the first Y% contribution. For example, they might offer you a 50% match on your first 6% contributions. This means that if you make $50,000 a year, and you put in zero dollars, your company will match zero dollars, giving you a zero percent return on your money. If you were to put in 6% ($3,000), the company will match you 3% ($1,500). Therefore, you will have $4,500 in 401K contributions for the year, and your immediate return was 50% on your money. If you were to put in 15% ($7,500), the company would still only match 3% ($1,500). Your immediate return is now only 20% on your money. The moral of this story is that if you do not invest up to the company’s matching percentage, then you are giving away free money. At which point you get up to the company’s matching percentage, you should consider all of the investment options available to you before you decide to continue investing much more into your 401K. I am not saying that investing 15% in your 401K is a bad idea (in general, it is not a bad idea at all), I am only saying that the minimum you should invest is enough to take advantage of the full company match, and after that you should investigate all of your options before deciding which vehicle to put the rest of your money into.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

What Should I Do With My Old 401K?

What Should I Do With My Old 401K?

If you have left a former company, you should always move your old 401K into an IRA (Individual Retirement Account). There are many reasons for this, but the most important one is that your old company retains the power in your old 401K. By that, I mean that your old company can decide that suddenly your investments must change from Fidelity to Vanguard or vice-versa. They can also freeze your asset movements with little/no notice during blackout periods. In addition, you may only invest in the asset choices that your company allows you to, whereas in an IRA you have none of these aforementioned issues.

How Should I Do It?

First, find a financial advisor if you don’t have one already. If you are completely adverse to hiring a financial advisor, then look for a free or cheap account on E-Trade or Fidelity, but this will require more information than I will provide on this site. Basically, once you have a financial advisor, who you trust, they will be able to very easily set you up with the transfer paperwork necessary to move your money into an IRA. They will also be able to give you more information than I am about to provide on the type of IRA options that you have. More importantly, your 401K will likely be liquidated and put into your IRA in cash, therefore you will need to buy investments when you begin your IRA, and your new financial advisor can help you make those choices.

What Types of IRAs Are There To Choose From?

The first type is a traditional IRA. This IRA is taxed almost identically as your 401K (although there are some states where it gets slightly advantaged tax benefits, please contact a tax attorney or financial advisor for specifics in your state). If you move your old 401K into a traditional IRA, there will be no tax event that year, meaning it will not cost you anything, you will not pay any immediate taxes, and you will not begin paying taxes until you begin withdrawing the money (just as you would have in the 401K). This is the type of IRA that over 90% of people will wind up using in this scenario, but there are valid reasons for looking at the second type, which I am about to talk about.

The second option you have is rollover the old 401K into a Roth IRA. Roth IRAs are taxed at the time of the rollover. This means that if you rolled over a $20,000 401K into a Roth IRA, and your tax bracket was 15%, you would theoretically pay $3,000 of taxes in the current tax year. The reason you might want to do this is because the Roth IRA will then grow tax free rather than tax-deferred. Please take a look at the “Retirement Tools” Section where I discuss this in further detail, so that I do not provide a lot of repeat data on this site. To make a long story short, two main types of people should be interested in rolling over their 401K into a Roth IRA instead of a traditional IRA:

1. If you are younger than 40, you have the money to pay the taxes, you are not planning on removing the funds early, and you believe that your income will continue to rise throughout your working career.

2. If you will earn an unusually low amount of money in a particular year (e.g. if you got laid off, started a new business, or took a year off), you might decide to roll over the 401K and pay the taxes at a very low tax bracket, rather than waiting until retirement when tax rates or your income may rise from today’s date.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.