Archive for the 'Reader Questions' Category
photo figure credit: _e.t
A reader writes:
“Due to current economic trends I have suffered a rather costly loss and one of my 401K’s dropped below the minimum of what they need to be to stay open. I got a letter in the mail with options of what I can do with it. I was wondering what you would do in this situation?”
While the loss of value in your 401k is unfortunate, this situation forces you into a beneficial situation. Generally 401k plans have fewer investment options and sometimes more restrictions on how frequently you can move into and out of those options. Moving your retirement money to an Individual Retirement Account (IRA) opens up a lot of investment options.
The major question is what type of IRA to use: Traditional or Roth. A Traditional IRA is very much like a 401k in that money is put into it pre-tax. Money and earnings in a TIRA grow untaxed as well, and only withdrawals are eventually taxed. A Roth IRA uses post-tax money. Earnings and withdrawals from a Roth are non-taxable, and you can also withdraw principal (but not earnings) from a Roth IRA at any time without penalty (though this practice is not recommended by this blogger).
The question of choosing one type of IRA over the other can be very complicated, but the general rule of thumb is to consider whether or not you have yet reached your full earning potential, and therefore whether you are yet at your highest tax burden. If the answer is “yes”, then a TIRA is probably your best bet, since you will likely have a lower tax burden in retirement, and therefore you want your earnings taxed then. If the answer is “no”, then a Roth is probably a good choice because your retirement earnings will likely be higher than they are now, so you want your contributions taxed now.
With all that said, I think there are a few questions that you have to ask yourself to make the best choice:
1. How much money is in the 401k that you are about to roll over? My presumption is that it’s not that much, otherwise the plan custodian would not be closing your account. In the grand scheme of things, this probably means that it will not make that much difference one way or another which option you choose. However, the amount you have to invest may have some effect on what fund options are available to you in the particular option you choose.
2. Are you currently contributing to an IRA and/or do you plan to contribute to one soon? Related to Question 1 above is the issue of how much money you have to invest. The fund option availability issue can be mitigated very quickly if you’re already contributing to an IRA or plan to do so soon.
3. How much money do you make? Your income determines your eligibility for TIRA and Roth IRA contributions, which relates directly to Question 2 above. If you’re covered by a 401k plan at your current employer, then your Adjusted Gross Income (AGI — income after tax exempt deductions such as 401k contributions and Health Savings Accounts) has to be less than $53,000 if filing singly or $85,000 if filing jointly (there’s another pesky marriage penalty…) to be eligible to contribute to a Traditional IRA. The AGI limits are $99,000 for single filers and $156,000 for joint filers for Roth IRA contributions. Both types of IRAs allow up to $5,000 per person in contributions in 2008. There are a number of little nuances to these rules, so you should check the link at the top of this paragraph to see the relevant tables pertaining to your particular situation.
With all that said, here is how I see your options:
1. Roll your 401k straight to a Traditional IRA. This is the most common and straightforward move you can make. The biggest problem that you could run into is not being able to meet the minimum amount required to buy into a particular mutual fund. I’ll talk more about this in my next post on this subject.
2. Roll your 401k to a TIRA and then recharacterize it to a Roth IRA. This may be a good option if your AGI is less than $100,000. The downside to this option is that you will have to pay taxes on the money you have invested as if it were income, and you will have to file some additional paperwork with your tax return next spring. Since it’s not a lot of money, the taxes won’t be that great. You can pay the taxes out of the principal or out of pocket. The latter option is preferred so that you keep the greatest amount of money working for you, but means you may have to come up with the cash in April if you’re expecting a refund but it doesn’t cover the taxes owed on the conversion. Example: If you have $3,000 in the plan and you’re in the 25% tax bracket, then you’ll owe $750 in taxes. You can reduce your principal balance to $2,250 to cover this, or you can come up with $750 on your own. The bonus to the 2nd option is that you get to keep that extra $750 in the plan and growing tax free for the next 30-40 years.
3. You can take a distribution on the money. This is probably the worst option (I like nuance, otherwise I would have said, “This is, by far, the absolute worst thing you can possibly do with this money.) If, for example, you happen to have a credit card that is currently charging an exorbitant interest rate, like in the 30% range, then it may be in your best interest to use this money to help get out of that pickle before refocusing on retirement. The downside to this option is that not only will you have to pay taxes as in Option 2, but you will also face a 10% penalty on the early withdrawal of 401k funds if you are under 59 1/2. So that $3,000 turns into $1,950 just like that (imagine fingers snapping). Just to be clear: Option 3 is nearly always a bad idea.
In my next post on this topic I will cover how to pick a new custodian for this money, how to set up an IRA, how to move the money from the 401k to the IRA without incurring expenses or taxes, and some thoughts on good fund options to get you started.
What would you do if you found yourself in this reader’s shoes? Do you prefer to use Traditional or Roth IRAs for your non-401k retirement investing? Let’s hear your thoughts in the Comment Section!
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photo figure credit: ScrapperMom
Michelle asks:
"How was the vacation?"
In a word: Fantastic! We got to meet the newest member of our extended family (on that side, anyway…) who is already one and half! We got to catch up with family that we haven’t seen in over 2 years. We got to know new wives, girlfriends, and old friends a lot better. Thanks to all of them for taking the time out of their busy schedules, providing places to stay, cooking dinner, etc. This picture is the pool at the hotel in Orlando, which the kids loved.
As a follow up to my original post on this topic, I thought I would offer a post-trip analysis on how we did financially. It’s important to note that while we put nearly everything below on our rewards credit card, it will all be paid off by the end of the month because we had already set aside the funding for this trip.
I’ll start with the area in which I feel we did the worst from a frugal perspective: Dining out. In total we purchased 9 meals out and they totaled $378. This breaks down to $42 per family-meal, or $17 per person per meal if we count dear daughter #1 as a half person who shared what we ate most of the time. Given that we ate a total of 22 meals, 9 represents only 40%. We easily could have converted a couple of dinners out into dinners at home, but then again, we were on vacation… We did manage to convert a couple of these meals into lunches the next day since the portions were often too big! I should also point out that this total included drinks with meals as well, which as you know can get pretty expensive. During one meal we paid close to $9 for an 8 ounce rum and coke!
Relating to dining, our grocery bill came in at $141. As described in the initial article, we had a lot of opportunity to prepare meals, especially breakfasts and lunches. If you put all of our food spending together, the per person per meal average comes down to $9.50. The grocery bill includes a 12 pack of beer that we brought to a party, as well as a lot of bottled water that we wouldn’t normally buy at home, but the local water was terrible!
In the category of transportation, we got a great deal on airline tickets: we purchased 3 seats for $597 on JetBlue. The in-flight entertainment, especially Animal Planet and the XM station for Radio Disney went a long way to keeping our 21 month old busy on the flight each way. In total, we spent $378 (Yes, exactly the same as on dining out!) on the rental of a mini-van and the fuel we needed for a week. We drove the van over 500 miles since we went down to Disney, and much of the time the van was nearly at capacity with 4 adults and 2 toddlers in car seats.
Our short jaunt to Disney cost us both on the ticket side and on lodging. We somehow thought that we still had tickets that we could use at Disney, which would have given us “free” entry to the park. Unfortunately this was not the case, and we ended up having to buy 2 adult, single day passes for a total of $160. Yes, that hurt. The Magic Kingdom is a great place, but honestly I think it’s looking a bit dated, and I’ve been to a number of better parks in recent years that cost a lot less than this. But it’s the American Way to take your kids to Disney, right? The lodging for one night was not bad at $90. This was our share of the split on the condo that we shared with my cousin and his family.
We spent a total of $23 on items that didn’t fit into any of these other categories. This included a Christmas ornament from Disney, and a couple of magazines at the airport. We successfully resisted the urge to spend $17 on a fan-assisted squirt bottle in Disney on a 93 degree, scorching hot day. We also avoiding having to purchase every cute stuffed animal that DD#1 got her hands on.
Last, and far from least, we spent $720 at the Dog Kennel. As outlined in this article, our dogs are expensive. It definitely hurts to have to budget 30% of every trip we take to kenneling the dogs, and it’s the first thing that pops into my head whenever we consider a trip. We spent a few years trying to find the right mix of costs for kenneling. In this business, the saying is true: You get what you pay for. We were horrified upon retrieving our dogs from a budget kennel on one trip, and they didn’t want to come home when we tried to get them from a super-expensive kennel. Eventually we found a “just right” kennel that treats them well — but not too well. This is certainly an area that will factor into any future pet decisions. It’s a good argument against having two pets.
In total, we spent $2487. This is a lot less than ScrapperMom and I spent on a lavish Quebec trip a number of years ago, but more than we have spent on a vacation in some time. Was it worth it? It’s hard to put a price-tag on the experiences that we had. If pressed, however, I would have to say that the cost was worth it since it meshes with our values: notice that we have only a couple of magazines and a Christmas ornament to show for this expenditure. We don’t place a high value on “stuff”, but rather experiences and time spent with family and friends. You can’t put a price on that. This trip would have been a lot less fun if we just went to Florida by ourselves…
We’re already looking forward to a mini-vacation in November as we travel to New Jersey to celebrate a wedding!
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A reader recently asked me for more information about opening an ING Direct account. I have mentioned ING in the past, and recommend this bank for anyone who:
- Is looking to establish a savings account
- Wants to earn a better interest rate on existing savings
- Likes free money
- Wants to allocate separate pools of money to separate savings goals
What’s so great about ING? Well, there’s nothing particularly spectacular about any one aspect of ING, but it has a lot of really great things going for it, including:
- A rate of return far higher than the national average for savings accounts, currently 3% — although it’s not typically as high as some other online banks
- No fees
- The ability to create “sub-accounts”, which is useful for categorizing savings goals
- Anecdotally popular customer service*
- Ease of use; link your current checking account to your ING account to move money back and forth as necessary
- FDIC Insured
- Signup bonuses
So, if you have any of the desires listed at the top of the article, and enjoy any of the features listed above, then an ING account may be for you. If you would like to sign up, then you may want to act quickly. By using one of the referral links below, you will get a $25 bonus if you make an initial deposit of at least $250. That’s an instant 10% return on your money. At the same time, I will get a $10 bonus as well for the referral.
These links work just once, so if you use one, let me know so I can remove it. If a link doesn’t work, let me know and I will remove it. If there are no more links, let me know and I will add more. Contact me if you have questions or concerns. Happy saving!
ING Referral Link 1
ING Referral Link 2
ING Referral Link 3
ING Referral Link 4
ING Referral Link 5
* The personal finance blogosphere seems to agree on this point.
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Feeding the Firefoxes
photo figure credit: Glutnix
It’s been another busy week in the MITBeta and ScrapperMom household. But I’m feeling like things are a little more under control since I started reading the now well known but still great book Getting Things Done by David Allen. I’ll have more on that in an upcoming post, but in the mean time I wanted to share some of the best articles that I read this week:
In National News:
With this week’s hike in the minimum wage, Nickel examines the historical minimum wage level relative to the value of a dollar and finds that those on minimum wage have been seeing the value of their salaries fall for the last 25 years.
The Freakonomics blog wonders are we a nation of financial illiterates? I’ll reserve judgement for now, but what do you think? Did you answer the quiz questions correctly?
Personal Finance
Shilpan at successsoul.com reposts Warren Buffett’s 7 Secrets for Living a Happy and Simple Life. There’s some great advice here that really forms the basis for most personal finance: don’t try to keep up with the Joneses, be happy with who you are, not what you have, etc.
Mrs. Micah writes about an error in her paycheck and how thankful she is that she is not living paycheck to paycheck. This reminded me of something similar that happened to ScrapperMom a couple of months ago. Mrs. Micah also has some great tips for breaking the paycheck to paycheck cycle.
Home Economics:
EconomistMom writes about “a big family infrastructure day” that took a serious bite out of her bank account. She makes a couple of great points in this article, especially in explaining why the health care problem is such a difficult nut to crack.
J.D. asks readers to help a fellow reader who asks “how can I get my wife to talk about money?“ Chronic disagreements about money are cited as a leading cause of divorce. However many astute readers rightly point out that it’s never just about money. As near as I can tell, open communication is the only way to truly make a marriage work. In fact, that’s the best way to make nearly any interpersonal relationship work.
Social Psychology:
Steven Levitt at Freakonomics shares a great anecdote about performing a blind taste test to see if his colleagues could tell the difference between expensive and more frugal wines. Can you guess what the results were? Apparently there is now scientific evidence to support the idea that taste can be influence by pre-conceived notions about something. I wonder if this means I can think my way into liking onions…
Giveaways:
Frugal Babe is giving away a $100 jewelry gift card to Diamond Nexus Labs in the spirit of switching away from mined diamond based bling.
Baby Cheapskate is giving away $200 worth of BumGenius cloth diapers. As you may know, using cloth diapers is a great way to save money and save the environment.
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Matt asks: “…is it actually the right time to be seeking leverage or playing it safe?”
Leverage (finance)
From Wikipedia, the free encyclopedia
In finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.
I think that it’s always smart to be seeking leverage, but only using it in a way that’s safe. Easy enough answer, right?
History teaches us that investment risks are not so much about losing your asset as much as they are about the asset being devalued at the time that you need to access your equity.
Many soon-to-be-former homeowners are learning this lesson the hard way right now, having used too little leverage in a bubble market under unfavorable financing conditions. But there are many others, myself included (I would like to think…), who used leverage in the same market, but have done so with better risk mitigation.
Let’s look at 2 cases:
1. 0% - 5% down, 3/1 adjustable rate mortgage: Fast forward to today, and you’ll see that the home has lost 10% of it’s value in the last three years, there’s a balloon payment due or the interest rate on the mortgage is rising beyond their ability to make the monthly payments. These people are upside-down on their mortgages now, they owe more than the house is worth, and barring an act of Congress (which apparently isn’t all that far fetched…) will be in for a world of hurt very soon. Strike 1: Negative Equity, Strike 2: Can’t afford the resetting mortgage. Either of these problems could likely have been overcome on their own, but the combination of them is the real killer.
2. 10% - 20% down, 30 year fixed mortgage: Fast forward to today, and you’ll find that even with a 10% market decline, this homeowner can still sell his house and afford to pay back the mortgage. However he has no reason to sell the house, because he bought for the long term, and he knows that he can afford to keep making the payments because those payments won’t be changing.
The lessons to be learned here are: 1. Be sure that you can afford to keep feeding an alligator until you have positive equity and 2. Be sure that the timescale of the investment matches the calendar date for when you need the money.
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