The Gig economy is NOW. Being self-employed offers incredible flexibility and ownership. One question that we hear often is, "how do I save for retirement without a traditional 401k." Don't worry, we've got you.Read More
What You Should Know About Mutual Funds And Exchange-Traded Funds
Financial planning and investing aren’t rocket science. It all boils down to this: set your goals, establish a smart, realistic strategy, and stick to that plan for the long haul.
Of course, when it comes to “buying” investments for your retirement account, you should be an educated consumer. There are thousands of mutual funds and ETFs to choose from when building your 401k or private retirement account. Many of these are aggressively marketed to the public. A basic understanding of fund traits will help you make better decisions, whether you are managing your own investments or working with a financial professional.
Here are some things to consider as you evaluate a mutual fund or ETF for your portfolio.
What’s the fund’s strategy?
The two categories of stock mutual funds/ETFs are growth and income. While both types focus on maximizing returns, their strategies are very different.
Growth vs. Income
Growth: Growth Funds offer the potential for higher returns with higher risks; they often perform in tandem with the overall stock market and do better when stock prices are rising, and can suffer when stock prices fall. These funds are comprised of shares in companies that focus on expansion and increased market share, and are best suited for higher risk tolerance and a longer time horizon. Netflix and Amazon are two good examples.
Income: Income funds, by comparison, are relatively conservative investment vehicles. Income stocks pay dividends that can be reinvested to turbocharge the growth of a retirement account. Income stocks tend to be shares in well-established companies in mature industries. Think Proctor & Gamble or Apple.
What’s the Expense Ratio?
The expense ratio is a measure of what mutual funds and exchange-traded funds charge shareholders to offset the fund’s annual operating expenses and is expressed as a percentage of the fund’s average net assets. Expense ratios vary widely based on the investment category, investment strategy and the size of the fund, with smaller funds tending toward higher expense ratios. You can compare the expense ratio of funds by looking at the fund’s prospectus, financial news websites, fund screeners and news journals.
How long has the fund been around?
When considering funds for your 401k or other retirement account, the life of the fund can be an indicator on how much to allocate to a particular fund. Newer funds carry more risk, as they may not have experience with market fluctuation, but they also carry the possibility of higher returns. Conversely, older, more established funds can sometimes weather the storm of a poor market more easily than their youthful counterparts.
These questions will serve as an excellent starting point for exploring a fund’s suitability for your portfolio. If you are working with a professional, ask these questions – and lots more -- before accepting her recommendation. If you are a DIY investor, scour the web for the answers, and additional background.
After all, we’re talking about your future here. You should know at least as much about your investments as you did about that 75-inch TV you bought last winter, right?
Follow, Like, and Tweet Us and let us know your questions and how we're doing.
You hear it all the time. On your TV, in your car, even on your computer. They’re all asking the same thing, “Are you saving enough for retirement?” I’m sure over the years that question has faded into the background. Don’t get me wrong it's an important question, maybe even the MOST important question on your path to retirement, but I can think of another question that can be just as important, but gets asked far less. That is, “Where is my retirement money going?” In other words, what type of retirement accounts are my savings going into and why. Maybe your company offers a 401k plan so you put your savings in that. Or maybe you listened to your parents and opened an IRA. Maybe you’re ahead of the curve and have both, or you might be reading this and have neither. The bottom line is where your money is going can be just as important as how much you save.
Let’s start with your 401(k)…
A 401(k) is an employee-sponsored retirement savings account. The money that goes into a 401(k) is taken out of your income before taxes, therefore, it is called pre-tax money. But don’t think you’re off the hook from the IRS just yet. They’ll end up getting their share when you withdraw money from your account, preferably after age 59 ½ otherwise you’ll be hit with a hefty 10% early withdrawal penalty.
Let’s stick with contributions for now, though. One of the best things about a 401(k) plan is not only can you contribute savings in pre-tax dollars, but your employer can also contribute money to your account. Some generous employers may even match around 4-5% of your salary. It’s like free money. This is why 401(k)s are so popular with employees that work for a company that offers this benefit.
Now on to your IRAs…
IRA stands for individual retirement account and comes in many different forms, but for the sake of time were just going to put them into 2 categories for now: Traditional IRAs and Roth IRAs.
Traditional IRAs are not so different from 401(k)s in the sense that the money that you contribute is also in pre-tax dollars. So to the IRS, it looks like that amount was wiped clean from your income. Just as with a 401(k), you will only be taxed on the money that you withdrawal from your Traditional IRA account. Again, preferably after you are 59 ½ so you are not hit with that 10% penalty. The good news with a Traditional IRA is that anyone can open an IRA as long as they are younger than 70 ½.
Don't forget about Roth IRAs...
Roth IRAs are a slightly different animal from the previous two. Instead of contributing your savings in pre-tax dollars, Roth IRA contributions are made in after-tax dollars. Meaning that the IRS will have already taken their share of the amount that goes into your Roth. This might sound like a bad deal at first glance, but it is actually a great deal for savers because it allows that money to grow tax-free all the way to retirement. The only catch is that technically you can only contribute directly to a Roth IRA in 2016 if you make less than $116,000 if you are single or $183,000 if you are married.
Okay, now where exactly am I supposed to save?
Now that you have a basic understanding of these three types of retirement accounts, I want to try and make some sense about how you should utilize them when saving for retirement. I like to think of savings in terms of a hierarchy so that I have a plan for every additional dollar that I make after all of my expenses are paid. The first two, and arguably most important, levels in the hierarchy involve building your emergency reserves and cash balance for any upcoming expenses. You can think of this as your “In case the income stops” and “Down payment” funds.
We’ll focus on these another day because they are extremely important, but today I want to focus your retirement savings and the steps that should be taken to utilize your various retirement accounts. If you are reading this, I am going to assume that you either work for a company that currently offers a 401(k) plan or will in the near future. If that is the case, then your additional savings beyond cash should go towards your 401(k) with the amount that your employer is willing to match. If they are willing to match a flat 4% of your salary, then contribute that amount. Maybe they will match 100% of the first 3% and 50% of the next 2%. In that case, it would be wise to contribute 5% of your salary to your 401(k) account. After all, as I mentioned earlier this is kind of like free money that you will thank yourself for later on in life, but that’s enough with the math for today.
At this point, you may be thinking, “Shouldn’t I just go ahead and max out max out my 401(k)?” The answer could be yes, but only if you/you and your spouse don’t qualify for a Roth IRA. If you do qualify, that is where your additional savings should go. So every remaining dollar that you plan to save after you have MATCHED (Not Maxed) your 401(k) should go into your Roth, up to the maximum contribution amount. As I said earlier, money in this account will grow tax-free all the way to retirement.
If you are an avid saver you may have some money left over after you have matched your 401(k) and maxed your Roth. This is when you should try to max out your 401(k) with your remaining savings. This is where a Traditional IRA would be funded only if you did not have a 401(k) and your income exceeded the threshold to contribute to a Roth IRA.
If you’ve made it this far, congratulations! You’re well on your way to answering the question that all of those TV commercials and radio ads keep asking. If you're still interested in learning more, click below.
Contributing to your 401(k) is the easiest way to put yourself in a better financial position in the future. If you only have time to do one thing, this is where to start. Here are three reasons why.
- It's simple
It's a very simple to take action. Just contact your HR department or go online to your 401(k) plan administrator’s website.
By enrolling in your 401(k) plan you're automatically saving and investing for retirement without having to pull the money from your paycheck yourself and then move it into an investment account. You can work towards your long-term financial goals without being distracted by your short-term goals.
Let's look at it this way, you have a goal to start eating healthier. You know that this takes discipline, and is typically very difficult to get started. If you were to subscribe to a program like Blue Apron, though, that sent you regular meals with fresh ingredients that you'd then put together yourself, it probably wouldn't be as difficult to get started or to stick to it. You'd be removing several difficult steps like finding a recipe and then going to the grocery store to pick up the ingredients. The process and discipline has been removed and all it takes for you to reach your goal is to prepare and consume the food.
Once you've set up your 401(k) contributions it's a little like this. You'll eliminate the difficult steps of saving, and immediately accomplish your goal of putting money away for your future retirement.
2. You get tax benefits today
Another reason to embrace your 401(k) is because of the tax benefits you'll receive today. The money that you contribute to your 401(k) is generally tax-deferred, meaning that you will pay taxes on it once you pull the money out of the account in retirement. Because of this, the amount of money you contribute to your 401(k) lowers your taxable income today.
For example, let's say that you have a household income of $90,000 a year, and you and your spouse each contribute $5,000 into individual 401(k) accounts. The U.S. government then will tax you based on a household income of $80,000. If you are married filing jointly, for 2015's taxes you might drop you from owing roughly $9,488 to $7,988. That's some significant tax savings!
An additional bonus to pre-tax savings is that you have a larger amount of money invested. More money = more compounding typically.
3. Free Money!
About 95% of 401(k) plans provide a company match, and the average company match is about 2.5% of an employee’s pay.
Let's use the eating healthy example here again. Imagine that after several months of using Blue Apron, they sent you a gift card to your favorite clothing store so you could buy smaller size clothing.
That’s what an employer match can do for you. It’s an extra benefit for doing something that you should do anyway. Again, it's free money!
The (Perceived) Negatives Of 401(k)s: There are a few things about saving in a 401(k) that some people don't like.
You can’t touch the money until you’re 59.5 without paying a stiff penalty. While this might technically be a negative, this policy is in place to help you reach your long-term goal of retirement. (We count it as a positive.)
Another drawback to 401(k)s is that they typically have a limited number of investment options, and the options are often expensive mutual funds. The good news on this point, though, is that today ETFs are being introduced in many 401(k) plans. These are less expensive investment vehicles.
When it feels like there are a million suggestions and “to-do’s” you sometimes need an easy win. Something that has a big impact, but that's an easy adjustment to make or to get started. Contributing to your 401(k) could be your easy win. Any financial matter like this is dependent on your own specific situation; however, generally speaking contributing to a 401(k) or another retirement plan has far reaching benefits for most investors.
I'm back for another week of Ashley Asks A Question. If you're an avid follower of my super insightful (read totally confused) questions you might have noticed I didn't post one last week. That's because we focused the entire week on financial New Year's Resolutions. While editing the post on Retirement I learned the contribution limit on IRAs was considerably lower than those placed on 401(k)s. How can this be, I asked myself. What is the meaning of this I shouted! So I did what I always do; turned to Wela COO Eddie Goepp, CFP® for answers.
PS if you didn't read the resolutions series you need to get up on that ASAP. There's even a killer worksheet in post number 1 to help you figure out where to start.
Let's get to it.
Why is the limit on IRA contributions so much lower than the limit on 401(k) contributions?
This is a great question and unfortunately the answer leaves much to be desired. The limits that were put in place were set by Congress and are adjusted every few years to keep up with inflation. That’s why you saw the IRA contribution limit go from $5,000 in 2012 to $5,500 in 2013. It’s stayed at that level through 2016. The very first limit was the lesser of $1,500 or 15% of household income.
The 401(k) (which refers to the section of the tax code which allows for these plans) was set up to help highly compensated employees defer income tax and supplement their retirement savings. The 401(k) has now grown to the most widely used vehicle for retirement savings. Currently the 401(k) contribution limits are $18,000 for age 49 and under; and $24,000 for 50+.
Considering the fact that not all companies offer these types of savings vehicles, the Individual Retirement Arrangement (IRA) was implemented in 1974. The two primary goals of the IRA were to provide a tax-advantaged retirement plan to employees of businesses that could not provide a pension plan; as well as to provide employees a vehicle for preserving tax-deferred status of retirement assets when they leave their employer (e.g. rollovers).
I could certainly speculate as to why these contribution limits are so different but I'm going to save my political commentary for more appropriate spaces like cocktail parties or networking events (jk). The fact, albeit probably not what you wanted to hear, is: because Congress said so.
Bottom line: While it's something that makes many of us shrug our shoulders at, there is no real answer. Even as adults we're still getting the response "Because I said so." So just follow the rules people.
Welcome friends to the second installment of Ashley Ask's a Question. Where the resident finance novice (me) asks Wela COO Eddie a question that is burning on my mind. Let's get to it.
Little backdrop to this question. I hear this word "rollover" in the office all the time. I had a general sense for what it meant. The more I started sitting in on meetings, the more I started to get worried that this is something I should have done. Then I really started to panic because, real talk guys, I have a 401(k) from my first job just sitting in Vanguard and I don't think I've opened a statement in 4 years (or worked for that company in 6...)
Gah, I know. Bad. But how bad? I had to find out!
What is a 401(k) rollover and is it bad if you don't do it?
A 401(k) rollover is different from a withdrawal. A rollover is when you move your money from the 401(k) account into another tax-advantage account. For example, if you have a traditional 401(k), meaning the money is pre-tax and growing tax-deferred, you’ll want to roll it into a Traditional IRA so that it can continue to grow tax-deferred and you won’t have to pay any taxes on the amount rolled over. Another possibility is if you've changed companies you might want to roll it over to the 401(k) provided by your new employer. On the other hand, if you withdraw the money, and deposited it into your checking account for example, then the IRS views that as income to you and you’ll be taxed on the amount at your ordinary income tax rate.
It’s not “bad” if you don’t roll your money out of the 401(k), however, it’s almost always “better” if you do. There are fees and expenses associated with a 401(k) that you won’t experience in a Traditional IRA so that’s one reason it’s better. Also, 401(k)s typically have limited investment options (think the list of mutual funds you have to choose from when you sign up for your 401(k)). In an IRA, there are very few limitations on the investments you can buy. In the case of an old employer, you are paying fees on a 401(k) you are no longer taking advantage of an an employee of that company.
Bottom line: Is it bad? No, but I'm not doing myself any favors by not rolling over.
Free… four simple letters that we all love to see or hear. So then why is it that 25% of employees turning down free money? Employees don’t have to work harder or change jobs to receive it, but by not contributing to their company 401k plan this 25% are missing out on free money. BOGO With Cash
Fifty percent of employers out there provide a 401k plan. This is a retirement savings plan that allows employees to save money while reducing the amount of their income that is taxed. Many companies also do something that is called “matching” employee contributions. I like to think of it as buy one get one free… for your money. These companies are saying to employees, “Put in $3,000 and we will give you $3,000.”
Some companies even go a step further where they will hold a buy one get half of another free. What do I mean about this? If you were to contribute $6,000 to your 401k plan, your company may give you $3,000 free for the first $3,000 you contribute… a buy one get one free type of sale… but then they may give you another $1,500 for the next $3,000 you save… a buy one get another half off sale.
In that example, you would be leaving $4,500 of free money on the table. That’s a couple Mac computers. Clark Howard wrote an article on this topic and found that we are missing out on an average of $1,300 every year in free money. Over an entire working career that could easily exceed $120,000!
Heck, that’s thousands of Mac computers and possibly three or four house down payments! However, many of us have a life to deal with, and that costs a lot. This keeps us from being able to save any money… so what do you do?
Taxes, Savings and Life
We constantly talk about TSL because it is such a powerful acronym/rule of thumb. The idea is to put 30% of your income towards taxes, 20% of your income towards savings and 50% towards life. If you are able to attain this rule of thumb you shouldn’t have a problem. What usually happens, though, is that we find that the life portion goes up and the savings portion goes down. That’s when we have to look at our discretionary spending. It’s that boring advice that we sometimes have to give, but take a hard look at your spending. Ultimately, if you want that free money you will be able to cut some of that spent money that you have discretion over.
If you don’t believe you can do it… I understand. Honestly, I didn’t believe my family could either. However, my wife and I went on Economic Shutdown for the entire month of May, and we were able to uncover money that was slipping through the cracks. We wrote about the whole experience which you can read here.
If you’re in the same mindset I was in April, then I challenge you and your family to try the Economic Shutdown. It’s never fun to be told that we have to cut our spending, however, my Economic Shutdown was a great experience because my family was still able to participate in fun activities like hanging out with friends. We were just much more mindful of our spending and prioritized our activities and budgets.
Pick Your 401k Account
Okay, so by not contributing to your company’s 401k plan means that you could be missing out on free money via the company match. Studies have showed that the average amount of free money that people are missing out on is $1,300. But when it comes time to start contributing to get this free money, many of us are faced with the challenge of whether to contribute to a regular 401k or a Roth 401k… which should you choose?
The Roth 401k is a new addition, and it has caused many of us to be confused simply decide to not contribute to a plan because we didn’t know which to choose. A traditional 401k allows you to add money to your account before taxes. Basically, this would be like getting paid a portion of our salary under the table and not having to report that money until we retire or maybe even later. The other portion of our salary that was not paid under the table would be taxed. This means that less of our salary is taxed today. Win!
However, with a Roth 401k we don’t get any of our salary paid to us under the table. Rather, we pay taxes on the entire thing today, but the benefit is that when we get to touch the money in retirement we don’t have to pay any taxes on that money.
The benefit of both of these vehicles is that if we were to invest the money that we put into either plan, the Roth or the traditional, into an investment we don’t have to pay taxes on gains or dividends. Say we buy Apple and are able to turn $100 into $100,000. We could sell Apple and not pay any taxes on the $99,900 gain. The difference, though, is that if I were to take that money out of the traditional 401k, I would be forced to pay taxes. On the other hand, if I were to take it out of the Roth IRA, I would not have to pay taxes on that.
The next obvious question then, is why would you ever want to use the traditional IRA then? The answer really comes down to when you want to pay Uncle Sam. Do you want to pay him today or decades from now? If you believe that you are paying more taxes today than you will when you stop working, then you should more likely use the traditional 401k. This is because whatever we contribute to the 401k is reduced from our taxed income. Then we aren’t taxed on the money until we take it out later in our life when we will owe Uncle Sam less.
Now if you believe you’ll pay more taxes when you stop working as compared to today, then you would want to use a Roth IRA. That way you’ll pay the taxes today when you’re being charged less by Uncle Sam as opposed to later in life when Uncle Sam will twist your arm for more money.
Get Advice On Your Personal Situation
Not contributing to your 401k can keep you from receiving free money, and if you make the wrong decision of whether to contribute to a traditional 401k or a Roth 401k can cost you money later in life. Both are really important decisions.
If you want some advice on your personal situation, then sign up as a free user of Wela and chat with one of our advisors. You can also set up a free 30-minute consultation with one of our Wela advisors for an objective review of your situation. They will lay out the pros and cons for each decision with regards to your particular situation. If you don’t have time to talk, you can still sign up as a free user and fill out a free game plan. A real advisor will review your situation and provide actionable steps for you and your situation.
Don’t miss out on free money. Figure out your plan of action to start contributing to your 401k, and start raking in that free cash today.
Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.
All right, so we may be sitting here and wondering why it’s so hard to get our own money out of the 401k. We could think of this as a hurdle, but really we should think of it as a favor because when we put money into our 401k we are forcing ourselves to save for retirement. This is a benefit that too many people don’t take advantage of, and ultimately regret when they actually want to retire. While we suggest you let the money in your 401k grow, sometimes life throws you curve balls and you just need that extra cash flow. Below are the best ways to access your savings without accruing a tax penalty for when you really need it.
Unreimbursed Medical Bills – If you have medical expenses that are greater than 10% of your adjusted gross income, and they unreimbursed deductible expenses (i.e. you have not been paid back and you can’t deduct them from your taxes) then you can take money out of your 401k for these. You have to do this in the year it happens.
Disability – You must be totally and permanently disabled to take out of your 401k without penalty… seems a bit rough.
Health Insurance Premiums* - This is starred because this really only exists for IRAs. You can take money out of your IRA once you have been unemployed for 12 weeks. Then the money can be used for health insurance premiums.
Death – This allows for heirs (with the exception of a spouse, which gets trickier) to take money out of the 401k without penalty.
First Time Homebuyers* - If you want to use your 401k savings for that first home, you will still have a 10% penalty… but if the money is in an IRA, that 10% penalty is dismissed. The caveat… you can only take out $10,000 total.
Higher Education Expenses* - Again, this is a scenario where the 401k will charge the 10% penalty, but an IRA distribution is penalty free. The bigger benefit is that the education expenses can be for you, your spouse, children, grandchildren or immediate family.
Paying yourself interest
Another option that can be utilized on 401ks is the ability to take loans from your account and pay yourself interest.
Although this sounds like a sweet option, we have to be careful on how we utilize it.
Most 401k plans allow for the employees to take a loan, but here is the caveat. There tends to be minimum amounts that must be taken and you can only take out the lesser of $50,000 or 50% of the vested amount in the account.
Say we have a $40,000 401k. We would be able to take a loan out up to $20,000 (50% of our vested amount).
The benefit of taking a loan from your 401k is that the plan doesn’t tend to care about why you are taking it or about your credit. You can also determine which fund (or funds) you want the monies to come from.
After you take your “loan” out, you then pay yourself the interest. The interest can’t be deducted for your taxes and the plan determines the rate (it tends to be lower).
Here is the kicker, though. If you take a loan and leave a company or are fired from the company and the loan hasn’t been paid off; well that amount will be taxed as ordinary income.
Sometimes you need the money you have saved before you or anyone else ever thought. Hopefully you can access it in a way that will not cost you extra.