Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Archive for the 'Retirement' Category

Ecto-2

Creative Commons License photo figure credit: AdamL212

When I was a kid my family had a Commodore 128 computer.  The vast majority of the time spent on this computer was in playing video games.  We had a game called Ghostbusters which, of course, was modeled after the hit movie of the same name.

The object of the game was to respond to calls of high paranormal activity in buildings all around New York City.  At the start of the game you are given an allowance of funds with which you can buy gear for catching ghosts.  The amount of money that you start with is enough to buy the cheapest car and a minimum of ghost catching gear — just 1 Slimer trap, and not even enough money to buy an Ecto-1.  When the trap is full, you have to return to Headquarters to empty the trap.  You get paid for each ghost that you catch.

As the game progresses, the Keymaster and the Gatekeeper arrive on the scene.  These two wander rather aimlessly around the city until they finally arrive at Zuul.  When they arrive at Zuul, if you have caught enough ghosts (it was never clear to me what metric was used to determine whether you had caught enough), you are given the opportunity to sneak through the legs of a dancing Stay Puft Marshmallow Man, take a trip to the roof of Spook Central, cross the streams and win the game.  If you manage to do all this, you get a code that you can use the next time that you play so that you can enter the game with more money.

What does all this have to do with personal finance and avoiding lifestyle inflation?  Well, it was my experience that no matter how much money I earned in the game, it never did me any good to buy more and better equipment.  Some of the options available were 4 different cars, each faster than the next, as well as the ability to buy several traps.  Having more than one trap allowed you to catch more than one ghost before having to return to headquarters to empty it, and having a better car allowed you to get from ghost call to ghost call and back to headquarters much faster.  It seemed, however, that the more money that you spent up front, the harder and faster you had to work to catch enough ghosts before the Keymaster and the Gatekeeper got together at Zuul. In fact, it was so hard to catch enough ghosts, that I was never able to beat the game by using anything more than the most minimal gear available.

I’ve been thinking of the parallels between this game and personal finance for a long time, and more lately as I read the popular personal finance book Your Money or Your Life by Vicki Robin and Joe Dominguez (more on that later…).  I’m finding it less and less useful to want to make more and more money if one of the big problems that it’s going to create for me is to need to keep making more and more money to support our lifestyle.  I would much rather be happy with what we’ve got and use any money that we happen to make above and beyond what we need to boost our retirement savings and lower our retirement age.  Coming to realize that we don’t need more stuff or a bigger house to make us happy has been a very freeing realization, and one that will allow us to maintain our lifestyle more easily over time.

Nail Biting

Nail Biting: A Bad Habit Creative Commons License photo figure credit: coxy

We’ve had a busy few months:

During this time, we have not paid very much attention to our finances.  Most of our finances are automated, so our bills still got paid on time, and I know that we’re generally doing okay.  However, I really can’t say whether we’re still saving enough, or even whether we have anything to save.  

Our busyness is really no excuse for taking our proverbial eyes off the ball here.  The truth of the matter is that I’ve had my head in the sand since shortly after ScrapperMom lost her job.  I really did not want to have to acknowledge the drop in income and figure out how to live without it.  As a result, I haven’t looked out our Spending Plan in months, I have no idea whether we’re spending more than we earn.  I do know that we have not yet made any retirement contributions for 2009 even though we are already 13% of the way through the year, and that’s starting to bug me.

Good personal finance is a habit like any other.  Breaking bad personal finance habits takes time, dedication, and work.  We’re all susceptible to falling back into our old habits, especially during times of stress, inattention, etc.  I gained a few pounds over the holidays (no excuse again…), and I’ve been working to take the excess off again.  Similarly, it’s time to get serious with our finances again.

Tomorrow I will draw up a new Spending Plan.  I will find money to contribute to our Roth IRAs, even if I have to take it out of our savings.  I will forget about our spending over the last month or two and focus on the future.  I will get back into the habit of good personal finance.

Do you fall back into old habits?  How do you get yourself back on track when you do?  Share your story in the Comments section below.

Holiday

Creative Commons License photo figure credit: muha…

Happy New Year to all!  As we close the chapter on one year and move on to a new one, I find this to be an excellent time to reflect on the state of life in general, and for the purposes of this blog, Personal Finance.  If you’re a regular reader of this blog you will know that I am a big fan of automating personal finance:

  • Our cash back credit cards get billed directly to our bill-pay account at our bank and the bank automatically pays the full balance every month.
  • ING and Vanguard both automatically withdraw pre-set amounts from our checking account monthly to cover various savings goals like increasing the size of our emergency fund, Roth IRA contributions, savings to cover annual payment to insurance, etc.
  • Bill-pay automatically pays all of our fixed monthly expenses like our mortgage, student loans, car loans, etc.

The only things that we ever have to really worry about paying on time are utility bills, gas and electric.

Given this level of automation, it’s easy to neglect our finances.  They’re not really neglected, but they’re not always getting the attention that they may deserve.  Sometimes we’re saving too much or too little.  Sometimes we’re spending more than we should and don’t realize it.  Sometimes we need to shift saving priorities because goals have been met or circumstances have changed.

I’m apparently such a work-a-holic that I had to take the last several days of the year off in order to burn, rather than lose, vacation time.  I spent the better part of one day and small parts of others catching up on our finances — a Personal Finance Holiday of sorts.  I’m not by far the first person to propose such a concept, and I’ve thought about taking a Personal Finance Holiday for a long time, but didn’t think that I had enough personal finance “stuff” to do to fill up a whole day.  Well, after neglecting to even open Quicken since mid-October, it turns out I did have a whole day of catching up to do.

Usually a Personal Finance Holiday is used to get going on all of the little things that you’ve been meaning to do, but haven’t found the time for (you have been meaning to do these things, haven’t you?):

  • creating a Spending Plan
  • opening a new Savings Account
  • starting an IRA savings account
  • buying life and disability insurance
  • opening a 529 account for your child(ren)
  • writing down or benchmarking your Personal Finance goals

Reading any of the myriad of Personal Finance books available can leave one overwhelmed by the number of things that you realize that you should be doing with your finances.  Taking a PF Holiday gives you the perfect opportunity to sit down and bang all of these items out in one shot.  It also gives you time when you would otherwise be unavailable to do all of the little things that might distract you from actually getting this stuff done, without feeling guilty about it: Can’t do it on Saturday because you have to spend time with the kids; Can’t do it on a holiday because you have to spend time with grandma; Can’t do it on a vacation day because you have to run all those other errands that you’ve been neglecting; Can’t do it on a sick day because, well, you’re sick (right?).

Maybe you’re thinking that you can’t possibly take a PF Holiday because you don’t have any vacation time.  Well, take it unpaid.  That’s right, it might not sound very frugal or financially prudent to do so, but let’s look at what a PF Holiday is worth:

  • If you use your PF Holiday to open an IRA and put just $100 per month into it, you’ll have $1,227 in one year at a modest 5% average return, and $15,528 in 10 years.
  • If you setup a disability insurance policy, you and your family will likely be able to maintain your standard of living should you become disabled.  If you can’t work for 10 years, this might be worth a quarter of a million dollars
  • If you set up an emergency fund, and use this fund instead of a credit card when a true emergency rolls around, you might save $1,400 in interest on that credit card.

If the average person makes $40,000/year or about $20/hour, then the cost of a PF Holiday on unpaid time is just $320.  It’s actually even lower than that since you won’t have to pay taxes on money that you don’t make (or conversely, if you had worked the 8 hours you would have brought home closer to $250).  So a small $250 investment could be worth tens or even hundreds of thousands of dollars over the next decade, and even more beyond that — perhaps even enough to vacation at the beautiful looking spot in the photo above!

In our case, we already have most of our Personal Finance stuff under control, or so we’d like to think, so the PF Holiday was used to catch up on what’s been going on, make sure that everything is going the way it should be.  It was also used to tweak and steer the various Personal Finance vehicles toward their respective goals.

Have you ever taken a Personal Finance Holiday?  Do you need to take a Personal Finance Holiday?  Do you have any new or redoubled goals for 2009?  Let’s hear about your experience in the Comments Section below!

If you liked this article, you may be interested in seeing some related articles:


Luxury

Creative Commons License photo figure credit: jonworth

The central tenet of personal finance is to spend less than you earn.  A close corollary to this is to learn to live with what you have.  If you can learn to be happy as things are, then it makes it easier and easier to save more and more as time goes by.  I wrote about these ideas in one of my first posts at this blog.

Last week, I found out that I am getting a raise to go along with a promotion that I got a couple of months ago.  The challenge with getting a raise is to keep the central tenet and the corollary in mind: don’t increase your standard of living, and put most of the raise to work for your future.  To do otherwise is what is commonly referred to as “lifestyle inflation.”

Lifestyle Inflation occurs when people continue to increase their standards of living as their means increase.  There is generally nothing wrong with enjoying a higher standard of living — if you can afford to.  Many people are already right on the edge, living paycheck to paycheck, and one unplanned expense away from financial disaster.  However, when these same people get a raise, they raise their standard of living so that they are now spending all of their new income, but are still continually on the edge of ruin.

There are two ways out of this cycle: spend less or earn more.  Most of us have a great deal of control over the former, and at least the perception of very little control over the latter.  In order to break out of the paycheck to paycheck paradigm we have to trim our budgets so that we have some money to save each paycheck, not succumb to lifestyle inflation, or do at least some combination of both.  (Of course, another easy way to avoid lifestyle inflation is to have your spouse get laid off in the same week that you receive your raise!)

Many people, especially in this economy, are lucky to be getting any raises at all, and those that are may still not be keeping up with inflation.  However, it still makes sense to me to try to forget about the raise when you get it and focus instead of how that extra money can be used to advance your financial plan: paying down debt, additional retirement savings, down payment fund, new car fund, emergency fund, college savings for the kids, increased charitable contributions, etc.

Another great strategy, if you can’t stomach the idea of never getting a raise is to split raises with yourself. While it may sound crazy, splitting raises with yourself will still allow you to enjoy some of the benefits of your newfound wealth, but also advance your overall financial plan.

Realizing that “stuff” doesn’t make you happy can be very empowering.  If you can forgo lifestyle inflation for an extended period of time, you can quickly get to a point where you are saving a substantial amount of your income.  I recently read a story about a couple who saved raises for 10 years (looking for a link, anyone have one?)  Imagine for a minute how early you could retire if you were saving 30% or more of your income.  Avoiding lifestyle inflation also offers more security: if you only need a fraction of your income for your base needs, layoffs and other economic crises will be far easier to weather.

Ultimately though, none of this matters if you don’t have a spending plan, don’t pay yourself first, and don’t track your spending.

Are you guilty of lifestyle inflation?  What do you do when you get a raise?  Let’s hear what you have to say in the Comments Section below!

If you liked this article, you may be interested in seeing some related articles:


401k tip jar

Creative Commons License 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!