Welcome to Financial Spiderplant!

I received the following e-mail and hope that this can be helpful to others. If you have any financial questions, please feel free to write me at david113@gmail.com

Hey David,
I need some financial advice. So I just graduated from college and I am one of the few people that care about saving up for retirement. My company matches the first 6% of my 401(k) contribution. So obviously I want to put at least 6% in there. However then I am not sure what to do. Before I graduated, I always took 10% of my paychecks and put them into an ING savings account. But I feel I can do something better with my extra money. Where should I put it? Put more in my 401(k)?
Also, whats better for my 401(k): before-tax and after-tax contributions?

Thanx
- Jay

Jay,

First, congrats on saving for retirement and managing to save additional income rather than enter the world of debt. Putting enough money into your 401K plan for the company match (6% in your case) is the best first step towards early retirement . Since the company match provides you with an immediate 100% rate of return on your investment, it will contribute greatly towards your growth in net worth and standard of living once you leave the workforce.

What to do after getting the 401K match depends on your situation but here is what I would recommend.
-After getting the full 401K match, focus on making contributions to your ROTH IRA. All contributions to your ROTH are after tax and once into a ROTH account, will never be taxed again if you leave those funds untouched until retirement. You can contribute $4,000 for 2007 until April 15th 2008 and your contributions for 2008 can be up to $5,000. If your focus is to build your retirement accounts, there is no better way to do this than in a ROTH IRA.
-Once you are fully funding your ROTH, you can opt to put more money into your 401K. If your company offers a ROTH 401K (funded with after tax dollars) you should contribute to it. As with a ROTH IRA, contributions are made with after tax dollars and are not taxed again as long as you don’t withdraw funds until retirement. I cover more about ROTH IRAs in this posting : Year Review : ROTH IRA Contributions If you don’t have the ROTH 401K option, additional contributions to your 401K are also an excellent route.

OR
-Once getting the 6% company match and funding your ROTH IRA, you are saving more for retirement than most other individuals in the world. It might them make sense to focus on building taxable account assets so that you can enrich your lifestyle before you reach retirement . You could open an account at Schwab, Sharebuilder, or other brokerage account and start learning about investing in stocks. I would recommend getting a subscription to Investors Business Daily, Forbes, Smartmoney, or major financial publication that can help you to learn about strong investments to help you build your net worth.

Your strongest choices in my opinion are to focus on the ROTH IRA contributions and go from there with whatever fits your long term goals.

One’s choice of what to do with your free cash flow after the 401K match can vary and may depend on the following.
-do you have any other debts?
-do you have some money set aside for emergencies?
-Where do your priorities lie regarding your long term goals? (Home purchase, additional retirement contributions, or building money in taxable accounts for future spending before retirement)

If you have any other debts, it could be in your immediate interest to focus on paying down debt. If you choose this, focus on credit card debt, personal loans, or any form of high interest debt that isn’t a college loan or a mortgage payment. (Since interest payments on these are tax deductible and other forms of investment would give you a better rate of return.)

This isn’t always the case though, if you are eager to get the ball rolling early on your retirement, you might place this as a focus before paying off debt. With the current availability of very low interest balance transfers, a case can be made for the choice of carrying manageable debt levels while choosing to make investments that will yield a higher rate of return. This is the choice I made in The Importance of Saving for Retirement. (I recently re-transferred all of my remaining credit card debt to a Chase credit card on a balance transfer that charged no fees and will charge me 0% interest for 15 months from a 12 month Washington Mutual card offer that was charging me 4%.)

You mentioned that you had been putting 10% into a savings account before graduation. If you are continuing to do this, GREAT! Having a decent cash cushion is important in case an emergency comes up like unemployment, car repairs, or any case where you are facing a cash crunch. While many financial professionals recommend saving anywhere from 6 months to two years of expenses in an emergency fund (and this should be your ultimate goal) I don’t agree with this approach for young individuals just starting out. Putting away 5% of your income into a savings account (like ING or Emigrant Direct) is a great start towards building your emergency fund. It will take a while until you have a large amount of cash and should a drastic life event cause you to need cash quickly, you may end up falling back on credit cards for a short time, but the priority of building a large emergency fund may not be your focus when you are at a young age where you can put more of your income towards investments with a higher rate of return. Start out trying to save at least $1,000 and continue to build your emergency fund to a point where you feel comfortable.

End points:
-Make sure you have a budget! If you don’t have a budget, the possibility that you are spending money where you ’shouldn’t be’ or not effectively managing your cash flow is greatly increased.
There are many free budget templates out there, here are a few.
-Set goals for yourself. If you don’t have a goal, how can you measure your progress? I try to set my goals as high as possible so that I can challenge myself. High aspirations can drive you to do things you wouldn’t normally think possible.

There is a lot of information out there about what you should do to become financially successful, index fund investing, real estate, growth investing, REITs…the truth is that there are many ways to become financially successful and everyone’s path is going to be a little different since we all have different needs, goals, and risk tolerance. While I don’t have ‘the best’ plan out there, I’m trying to learn as much as possible and in the end, the desire to learn and better yourself is going to contribute a lot more to your eventual success than a couple pointers. Never stop learning.

Good luck Jay!

I’ve been reading up a lot about retirement savings recently.

During 2007, I managed to put away 22% of my income into my 401K. During the year, I carried a little debt that many would say I should have focused on paying off and I sometimes chose to allocate some of the money in my emergency account funding and put it into taxable investments that could boost my income stream or to make my ROTH IRA contributions because I was that focused on saving for retirement and boosting my cash flow.

I know that my focus was a little overzealous and at times I questioned whether or not I’d was taking the right approach but I’d committed to the task for all of 2007, so I did it. I changed my 401K investments to 18% of my salary for 2007 in order to focus more on taxable account contributions.

One of the Schwab podcasts recently mentioned retirement saving with the following:

“Meet our prototype young go-getter. Chris gets out of college at age 22, takes a few years to get settled and at age 25 gets a job paying $40,000 a year. Chris gets annual raises of 4.1% and a promotion every five years that comes with a 10% raise. Chris is a diligent saver, putting away 10% per year of pretax income until retirement at age 65. By then, Chris has accumulated a portfolio of $2.4 million, assuming an annual return on the investments of 8.4%. That $2.4 million is worth $840,000 in today’s dollars.”

We are all in a position where we can make a great difference in tomorrow’s standard of living with very little action today. The sooner you start, the sooner you finish. (1)

I started re-reading Jim Cramer’s Real Money : Sane Investing in an Insane World (An excellent book, you can read some experts here, courtesy of Google Books!) because I recently received a free audio download from AudibleBooks and I chose Stay Mad for Life: Get Rich, Stay Rich (Make Your Kids Even Richer), the book is narrated by James Cramer and it has some very specific and highly accurate information on issues that can really help to improve your future. I’m going to be posting my book review by the end of this week.(You can read excerpts here, thanks Google!)

Cramer mentions a period during his live in 1978 and 1979 when he was living out of his car in Los Angeles just two years out of college. Cramer writes, “Even though I had barely enough money to eat and pay the Allstate liability bill - I waived the collision! - I still managed to put away $1,500 toward retirement. That’s how important it is to start saving early. I put the money with Fidelity and the compounding of that $1,500 would be enough for most people to live on for several years of retirement. The logic of equities through thick and thin is that powerful.”

Look, everyone has it as their own choice whether or not they are going to save for retirement, go into debt, or just ‘live life like a normal person,’ if you are saving for retirement I congratulate you, if you are not saving for retirement…I wish you well and hope that you change your mind.

If you choose not to save for retirement , you are placing your bet on one of two options.
1. You want to work forever, believe that the government will adequately take care of its elderly, or are otherwise taken care of whether it’s through inheritance, winning the lottery, or through any other means. (2)
2. You choose to face the fact that you will someday desire freedom. True freedom; where you have the means to a life of quality. You own up that it is something you should be doing now and that the underlying math actually is kind of interesting. (3)

Retirement is something that everyone should be aware of (if even only to hold the smallest base of financial literacy), if you currently rely on your job income for living expenses and could not continue the same standard of living if you stopped working, someday you’re going to retire and you’ll need a source of income. Starting early; hold the path. The sooner you start saving, the quicker your money will work for you.

Invest in your 401K, keep bumping up contributions until you reach your company match and look into full funding IRAs, and then look towards taxable accounts; because taxable accounts are what will be funding your lifestyle until retirement and THAT is where the fun is!

*:
(1) Philanthropist, jet setter, teacher, parent that spends more time with her kids, or a life of leisure in that $5,000 Brookstone chair that you never think you’ll ever actually buy!
(2) Like if you have a simple life and don’t need much income to support you or just haven’t been converted to option 2 yet.
(3) $1,500 dollars invested in high quality dividend paying stocks will be worth $67,888.88 in 40 years if it compounds at 10%! (Put that $1,500 into Altria and may be worth $1,577,501.26 seeing as how Altria has managed a historical 19% rate of return.

A loan can be taken from your 401K for any purpose: a home loan, medical expenses, or to buy a 103 inch plasma tv! (I wouldn’t recommend taking out a loan to buy stuff though!) These loans are usually taken out as a lump payment for a specific purpose, but what if accessing the funds in your 401K was as easy as swiping a card? Now it is.

ReservePlus is a new program that has been created by The Reserve, the company that introduced the money market fund (that cool instrument that allows you to get such 4%+ interest rates at banks rather than a nominal .25% or nothing).

The program works as follows:
1. You have a 401K account at XYZ company
2. XYZ company signs up as a participant with ReservePlus
3. Employees can now transfer funds to a loan line held by ReservePlus
4. You use a debit card to make withdrawals, purchases etc and repay your loan in the same way you would make credit card payments

The primary advantage of a ReservePlus account is that you are not required to immediately repay any retirement account loans in the case of job loss etc, you are given more leeway with your loan repayments and you also have the ability to quickly access funds should the need arise.

While the potential advantages of a 401K debit card are great, there is also a horrible downside. The current dynamic of accessing 401K funds has now changed from one where you previously had to fill out papers, make phone calls, and allow for your request to be processed, approved, and for a check to be sent to you for your loan to take place. Now, it is possible to get a card and readily use your card for any purchase you could make with a credit card. When you make funds more readily available for consumption, many people are more likely to use the funds for impulse buys, non-emergency cash, or other purchases that may not be in their long term self interest.

Taking out a 401K loan is a pretty serious move and is something that I would prefer to avoid in all cases. For younger generations that are not going to receive enough government benefits to cover basic living costs such as rent, food, and medication, retirement accounts will be the primary source of living expenses. To encourage the creation of programs that promote quick access to funds that should remain invested in tax advantaged accounts is in the disinterest of the future well being of Americans.

Not only does ReservePlus charge a 2.9% higher rate of interest on their loans and charge initial account setup fees, they are also set to offer automatic withholding from one’s paycheck so that loan repayment funds aren’t even seen except on your pay stub. By promoting programs that decrease the cash flow, disposable income, and overall available funds of individuals who by and large do not realize the repercussions of their actions due either to lack of research, available information, or their misguidance by ‘informed individuals,’ we ally ourselves with increased risk and unsure futures while we should be promoting an environment or security and debt adversity.

I’m certainly not an advocate or keeping people from accessing money that they have saved but when it comes to dealing with your retirement account, it is an account for the future and a potential source of financing in the case of a home purchase and medical emergencies; a 401K is not and should never be treated like an open line of credit, a checking account, or an account whose funds you can readily access with a card that you carry in your wallet for use at a moment’s notice.

Barry Kublin, president of BPA-Harbridge, summed it up very well: “It’s a young technology, and clearly requires education to address misconceptions,” says Kublin. “Do we deny the overwhelming percentage of 401(k) participants a portable convenient loan product that is responsive to their needs because of the irresponsible few?” While I fully agree that everyone should have access to the best programs out there, I have to question whether or not a program that seems to promote quick access to money that shouldn’t be readily accessed on a regular basis until retirement is the best program in existence.

Do your own research and if you are already seeking a 401K loan for a ‘qualified’ reason, ReservePlus might be the right program offer out there. My recommendation is to avoid any program that facilitates quick access towards your retirement funds unless you are actually in retirement.

Please feel free to send comments, opinions, or article requests to me at david113@gmail.com.

I also have a RSS feed you can sign up for here so that new articles can be delivered to you via e-mail.

Sources:
Benefitnews.com: The cost of an easy 401(k) loan? Priceless - Firm introduces 401(k) debit card
Thestreet.com : Just Put It on My 401(k) Debit Card

Your ROTH IRA. For some, it is just another form of retirement account. For others, it is a recognized vessel for your investment dollars to remain forever untaxed by Uncle Sam. A ROTH IRA is funded with after tax dollars; while you take the initial tax hit, funds transferred into the account will remain untaxed until you retire (unless you make an early withdrawal which comes with all sorts of tax penalties, solution: don’t withdraw from your ROTH until retirement under ‘any conditions*’) This means that regardless of any capital gains, dividend income, etc…you will NEVER PAY TAXES in your ROTH IRA account. For those in lower tax brackets than they will be during retirement (AKA: young people seeking cushy retirement), a ROTH IRA is the best investment vehicle out there. While you can’t escape death (except for me…that’s my new years resolution) you can now escape taxes. Contribute now and AVOID TAXES FOREVER. Sound too good to be true? It isn’t. (For additional information on ROTH IRAs)

The 2007 contribution limits on a ROTH IRA are $4,000 and $5,000 for those over 50. These limits will change to a respective $5,000 and $6,000 in 2008. Regarding retirement contributions, I would suggest maxing your 401K until you get your full company match** and then aiming to max out your ROTH IRA contributions. If you are short on cash and have ANY money/investments in taxable accounts, you should convert your taxable dollars into the untaxed ROTH environment.

In case the whole part about NO TAXES doesn’t convince you, consider this. I’m 25, I made my $4,000 contribution for 2007. Assuming 11% growth, by the time I’m 50, I’ll have $54,341.86 from just this year’s contribution. ($260,003.47 if I wait til 65.) That money can be drawn out whenever I feel like it with NO TAXES. That sounds like it is worth my while.

ROTH IRA contribution can be made by anyone with earned income under $99,000/year. Anyone making more than that can only make partial contributions up to $114,000 in annual income. This includes children. If your son/daughter has ANY earned income, they can make a ROTH contribution for as much money as they made during 2007 until they reach the $4,000 limit. If you want to establish an early habit of retirement saving, start with your child’s first job.

I was lucky enough to have my father inform me at the age of 15 (when the ROTH was first enacted) that he would match my summer wages of ~$1,200 into a ROTH account at Legg Mason. While I didn’t understand the concept of retirement savings (or even taxes for that matter) back then, I understood that sitting through a lecture, that was then more boring than anything I could ever imagine, about taxes, compounding interest, and some account that I might have even though was called a MOTH account was worth getting $1,200 and signing some papers that were put in front of me…even if I wouldn’t see the money til I was older than the planet and so old that I actually thought I’d walked to school uphill in snow both ways with newspaper for shoes.

My Dad’s ploy worked and at 16, I was excited enough for my ’summer bonus’ that I even had a friendly guy at Schwab help me get a hold of the forms to open my own ROTH account and buy into the Schwab 1000 index mutual. I’ve made my ROTH contribution every year since then and plan on continuing to do so until I’m no longer eligible. I was lucky enough to be informed early about the importance of saving for retirement early. While your children will not likely understand the terms you are using or the importance of your actions at present, they will eventually. If you have a child with earned income, you should seriously consider opening a ROTH for them, it will likely strike something in them…even if it is only the thought of some ‘free money’ from Mom and Dad.

You can make your ROTH IRA contributions for 2007 until April 15th of 2008. You have plenty of time to make your contribution but DON’T WAIT TIL THE LAST MINUTE!

Make the contribution, invest it wisely, and never pay taxes on those investments again. It really is that simple.

I welcome any feedback you might have! You can reach me at david113@gmail.com.

*It is ok to withdraw from your ROTH if you have no other way of raising funds for a home purchase, medical bills, or any REAL emergency. (No, it really isn’t…there are plenty of loan programs out there that will give you money…it is even preferable to take on credit card debt, in my opinion, to keep your money earning returns in an untaxed environment.)

** 401K Company match - If your company will match any contributions to your 401K, contribute enough to achieve that match. If they match a $100 contribution with $100 contribution (100% company match), that is a 100% immediate rate of return. If they match a $100 contribution with $50 (50% company match), that is an immediate 50% return. You won’t beat those rates anywhere.

I hope everyone is enjoying the holiday season!

This is the first of several posts relating to my financial progress during 2007. This post is relating to my 2007 401K contributions. A 401K is a retirement account that is funded with pre-tax dollars. Your contributions grow in a tax free environment until you retire. (You can take money out before retirement but I wouldn’t recommend it.) When you take the money out, you pay taxes on the withdrawals. A 401K plan is one of the easiest ways to save for retirement and many companies provide a matching contribution towards your account. (For more info than you’ll ever need regarding 401K plans)

First, for anyone out there making contributions to their retirement accounts, CONGRATS!!! You are doing the right thing. For anyone not making contributions to their 401K account, please start. It is a realization you will face sooner or later and starting your progress today is better than realizing that at 65, social security just won’t cut it and for most people under the age of 35 it won’t even be there for us in an effective capacity without major plan modifications.

401K Contribution limits for 2007:

$15,500 (Age 50+ can make an additional $5,000 catch-up contribution)

My 401K Contributions for 2007:

401K : $9,775.92 (includes employer match)

I’m extremely pleased with the progress that I have made with my retirement contributions. At the age of 25, this year’s contributions will grow to $132,810.41 by the time I’m 50 or $635,443.28 by the time I’m 65. (Assumes 11% growth in the compound interest calculator) That is not a small chunk of change…and that is from a SINGLE YEAR’S CONTRIBUTION.

For any young reader out there, NOW is the time to be making retirement contributions. Not in 5 years, not in 15 years, and certainly not in 25 years. Make your contributions early and allow the power of compounding interest to work in your favor.

It is simple to shrug and say “I don’t need to worry about retirement, I just started my career.” It is also just as simple to say “I just stated my career and I realize the importance of being financially stable. By making a few simple decisions, I can make sure that I have millions of dollars in an early retirement where I can travel wherever I want, whenever I want, and make regular charitable contributions in excess of my current annual salary without ever having to worry about losing stability.”

*Angry Dave* If you don’t make retirement contributions because you are unaware of the power it can give you, that’s ok. If you are reading this and choose to put off making retirement contributions, you’re a sucker. You’re a sucker because you have now been informed of a way to make a quick decision that will provide you with massive returns and you’re making the decision to ‘put it away to look at it later.’ Make a couple calls to investment brokers…opening an account takes less than an hour. Please don’t be a sucker. *Angry Dave*

Seriously, you won’t regret it.

Account Allocation:

You account allocation is one of the most important things to consider in any investment account. My account is held with Fidelity so I’m limited to choosing their mutual funds; they have one of the most diverse choices in mutual funds that I’ve seen.

As you can see, I’m heavily invested in international mutual funds. It is my firm belief that the long term future performance of international securities will outperform their domestic counterparts.

That’s all for now regarding my 401K. Don’t hesitate to send me any questions/comments at david113@gmail.com and feel free to sign up for my RSS feed so you can get my future postings delivered straight to your e-mail.

Retirement.

You’ve worked your years and are free to pursue travel, family events, hobbies, and ditch that daily commute. (It is also possible to cut your commute by moving to an apartment closer to work.) You have to spend less on gas, your work wardrobe, and the two cups of coffee that help keep you on game every day. You also get to stop your retirement contributions and start tapping that nest egg. For those of us that are young and keeping our retirement plan on check, we should have a pretty good sized account to draw from.

One of the biggest expenses that we pick up in retirement is the tax hit as you begin to sell off account funds to finance your adventures. Taxes and death, you can’t escape them…can you?

I’m 25 years old, living my life with as little debt as possible, making regular contributions to my 401K, fully funding my ROTH IRA, and am on track towards a great retirement. I’m not worried about my retirement (my regular retirement contributions should provide quite well) but the idea of keeping the tax monster from taking a 20% bite from every dollar I’ve put away pisses me off. I’ve been contributing to my ROTH IRA because I like the idea of paying the taxes on my income and then putting some of it in a vehicle that remain shielded from the grubby mitts of Uncle Sam in retirement.

Some of the farsighted individuals on Capitol Hill know the destructive power of taxes. This is what caused the creation of Public Law 105-34 in 1998 AKA: The ROTH IRA As of January 1st, 2006, the ROTH option is also available for 401Ks. Your contributions are made after you’ve taken your first and only tax hit, as your investment compounds and is eventually withdrawn, it will never again be subjected to a tax burden. Since I am currently in a lower tax bracket than I hope to be in during retirement, I’ve decided to take advantage of the ROTH 401K option offered by my employer. Many 401K plans still haven’t made the jump towards offering a ROTH 401K but hopefully, as the understanding of how great of a retirement tool a ROTH 401K is, more firms will begin to offer it.

I have been contributing 22% of my salary towards my 401K. (16% + 6% company match) My ROTH 401K contributions can be up to 6% of my salary so I have changed my contributions to be 6% towards my ROTH 401K and 16% to my traditional 401K. (10% +6% company match) For the time being, I am fully comfortable with the path my retirement accounts are on. My new ROTH 401K contributions should be an excellent step towards assuring a retirement that is less burdened by taxes and I believe that it is an excellent step by the government showing quite a bit of foresight. You might want to do yourself a favor and recheck your company’s policy on ROTH 401Ks, I doubt you’ll regret it.

One of my friends went on a debt crusade nearly a year ago. She was faced with ~$30,000 in debt; mostly credit cards, the interest rates she was being charged were insane and there wasn’t much progress in her debt elimination until she cut a lot of her costs and today, her debt has been reduced to ~$11,000. I was more than a little curious as to how she had managed to pay down nearly $20,000 in debt in only a year. She explained how she’d cut her costs, stopped shopping and eating out so often, and was on track to have no debt within a year. She had also borrowed $10,000 from her retirement account in order to give a huge push towards complete debt elimination.

There is nothing wrong with reducing debt, it is an admirable action. Borrowing from a retirement account is rarely a good idea. (Exception is first time home purchase which receives tax advantages) Borrowing from a retirement account to reduce consumer debt is a HORRIBLE idea. Here’s why.

Contributions to a traditional 401K/TSP are not taxed. Taxes don’t come into play until you begin to withdraw funds. This should generally happen during retirement because retirement withdrawals are not subject to penalities associated with other withdrawals. The problem with early withdrawals is that you face significant penalties and taxes; loans from retirement accounts must also be paid back. All repayments are made with after tax dollars which subjects you to double taxes. (Taxes when you withdraw and taxes on all money used to repay the loan.)

I’ll put it in dollar terms. A $10,000 withdrawal gets hit with an initial 20% tax hit (Cost: $2,000) this means you get a check for $8,000. You also have to pay income taxes on that amount. (Cost: ~$8,000) Don’t forget the early withdrawal penalty for non-qualified distributions, which is the case when raising cash for paying down debt. (Cost: $1,000) I got the calculations from Fidelity’s 401K withdrawal calculator.

So, a $10,000 withdrawal really leaves you with just over $6,000 after all penalties and taxes. These are only the initial costs though. What would have happened if you had taken another course of action that had left your $10,000 invested? If I were leave $10,000 in my 401K today, at the age of 25, and earned a 10% rate of return until the age of 65, I’d have $452,592.

So, in simple dollar terms, one can choose a $6,500 check today or a $452,592 check in the future. Putting it in terms of loss, that reduction of $6,500 in debt really just cost you about half a million dollars.

Hopefully, I’ve made a case for avoiding 401K withdrawals.

One of my friends recently obtained his MBA in finance and just started a new job. I asked him whether or not his company had a 401K plan and if he was contributing to his 401K. I figured this was a pointless question because he’s an absolutely brilliant, driven, and capable individual; his answer left me scratching my head. He said they did have a 401K plan but he wasn’t because he felt that he could always contribute at a later point in time and he wasn’t even sure if he would be living in the United States during retirement. (He is not a United States citizen.)

I talked with a couple people in my office who are also not United States Citizens and did a little research. I found out the following.

-Contributions to a 401K, Traditional IRA, and ROTH IRA are allowed by individuals earning income in the USA.
-Withdrawals are allowed regardless of where you live, you just need an account the institution can transfer money to.

It makes no sense to forgo contributions to a 401K if you are receiving any type of company match. Whether it is a 50% match of the first 4% you contribute or a full 100% match for up to 6% of your salary, it is an immediate 50-100% return on your investment. Returns like this aren’t found very often and should certainly be taken advantage of. Retirement may be 40+ years away but to ignore the effects of compounding interest overtime is not the wisest course of action. Using our compound interest calculator and www.salary.com, I plugged in a guesstimate of what would happen if he was contributing 6% of his salary with a 6% company match based on a low ball estimate of a salary for someone of his qualifications. ($65,000)

A contribution of 6% of his salary with the company match would total $7,800 and compounding at a rate of 9% for 40 years would total $244,993. With a figure at close to a quarter million dollars yielded from a single year’s contribution. I don’t think I need to make a further argument for why contributing early is important. If one waited until age 35 to start up the contributions, they’d end up with ~$100,000 and if put off til 45, a ‘mere’ $43,000

Check out this tool to see how much extra cash you’ll have to save if you put off saving.

Come on people, we’re intelligent individuals and should realize the base arguments behind our financial decisions. Contributing to that 401K early is a GREAT idea.

I won’t get started on the even more powerful ROTH IRA today but for the record:
“[A] paltry 19% of young workers say they plan to fund a traditional or Roth IRA this year.” (Source)

Have a good one!

Bankrate advisor Steve Bucci responds to a question about flushing a 401K account.

Dear Debt Adviser,
If the economy crashes, I know my 401(k) will disappear, but my debt won’t. So, I was thinking of raiding my 401(k) to pay off my credit card debt. What do you think?
- Stephen

Bankrate’s advisor Steve Bucci response to this question.

My understanding of the situation is this.
Steven has a 401K, credit card debt, and a fear that an economic downturn could leave him with a small 401K balance but an identical level of CC Debt. This fear might cause him to flush his 401K to make debt payments.

Stephen,
It is easy to justify taking money out of your 401K for qualified reasons. Taking money out of your 401K to pay down credit card debt compounding at a high interest rate would make perfect sense if there were no penalties associated with your 401K withdrawal. Unfortunately, there are penalties which are rather severe, for this reason, you should only take money out of your 401K in absolute emergencies. Your credit card debt doesn’t constitute an emergency so…NO, you shouldn’t take a 401K withdrawal to pay of your credit card debt.

I’m certainly not averse to using taxable account funds to pay down debt; I do have an issue with withdrawing retirement funds for debt payments. It just isn’t a wise idea. If your largest driving concern for this path is stemming from your fear of an economic downturn, you may want to change your 401K investments towards more conservative investments. This could be a money market/bond fund or, if your fear is a recession in the US and not one of global scale, you may wish to pursue one of the many viable international funds out there.

Qualified reasons to take a 401K distribution:
-Extreme Medical Expenses
-Extreme Debt where there is no other way of repayment
-Purchase of a home
-Unemployment (only after other savings have been depleted)
-Received notice that you won’t live to retirement and decide to bet your 401K on black in Vegas

Even with these cases, I’d rather carry the debt than raid my retirement savings. Maybe it is because I’m 25 and will more than likely have no Social Security; perhaps it is because I want to be assured that my retirement savings will be more than enough to provide as my sole source of retirement income with plenty leftover for my future family, mostly, it is because I’d rather pay down my debts without having the future growth of purchased assets increasing in value sacrificed. I just don’t agree with 401K withdrawals in general but certainly can’t make the case to take a withdrawal to pay down CC debt.

PS: It is my opinion that our economy isn’t going to crash anytime in the immediate future.

Additional Information:
401K penalties for early withdrawal: (See Fidelity’s info about 401K withdrawals or SmartMoney’s Should You Borrow From Your 401(k) or 403(b)? Calculator)

Happy Independence Day!

I started contributing to my 401K July 5th, 2006 when I switched over to a full time position with my current employer; I have now been contributing to my 401K for one full year.

It took a year of bumping up my contribution rate to one that was cutting the edge between saving enough that I could handle while maintaining sufficient funds for beer and steak on a quazi-regular basis but I’ve reached it.

I am currently contributing 16% of my salary to my 401K. Add in the 6% match from my company and I’m putting in 22% of my pre-tax income. I know that is a little absurd but by my reasoning, I’d rather save as much as I can for a few years so that the sustained momentum of my contributions will simply overpower other current investments. I’m making an initial full sprint out of the hypothetical starting gate for the a simple reason. If I start at a rapid pace, the compounding interest factor assures me of two things.

1) Not many people that start after me are going to catch me unless they are either making a much larger salary than I am or manage to save more than 22% of their income for their 401K.
2) I’m headed on a path that will allow me overtake individuals not taking advantage of their 401K or that are not contributing as high as a percentage of their salary.

Let me put some perspective on this statement. The contributions that an individual makes from the age of 24 to the age of 25 could allow them to retire at age 65, on those contributions alone, with over a half a million dollars. One single year of contributions = $500,000.

Lets say Sara’s making an annual salary of $45,000 and contributing 22%(16% + 6% match) of her salary to a 401K. She would end up with an account balance of $9,900 after one year assuming no increase in account value during that one year.
Taking into account future growth with NO additional contributions and Sara end up with the following figures from the compound interest calculator or feel free to work around with your own compounding interest calculator in Excel.

As we can see, Sara’s contributions from one year would increase in value to over half a million dollars as long as she achieves a rate of return of ~10% over 40 years.

Time to start looking for some great historical performers like Altria which returned investors with a 19.8% annual return. Damn, if Sara put her one year’s 401K contribution in Altria and achieved the same historical performance that Altria had from 1957-2003, she would have over 13.6 Million dollars today.

Don’t get me wrong, I think it is insane for anyone to continue saving 22% of their salary in their 401K for their entire careers unless they are really gunning for early retirement. Even then, it makes more sense to take advantage of other investment vehicles. For me, its more about getting in the early habit of saving a large percent of my salary so that as I continue to work, that 22% of my salary will already be accounted for. I am opposed to the traditional method of saving 6-10% of your salary and perhaps increasing this amount as you get closer to retirement. If anything, I’ll be decreasing my 401K contributions as I get older, providing me with more of my income to spend as opposed to less. It just doesn’t make sense to ignore the power that you could have working for you.

I can’t stress the importance enough of starting early in your savings. If you get a job when you graduate and become accustomed to putting away the generic 6%, that’s a good start; but, if you aren’t putting away anything, it will be extremely difficult to simply ‘pull’ an extra 10% of your salary out of thin air to start funding your accounts. You’ll have already become used to your current standard of living.