401(k) Spillover

401(k) Spillover - Some companies are including this new benefit into their retirement plan. With this plan, you are allowed to add to your 401(k) over the maximum amount allowable by the IRS ($18,000 in 2015). It is not pre tax like your first $18,000, but it can sit in your account for retirement nonetheless. 

The greatest benefit is to those who earn at the higher end and want to receive the full company match. Let's say that your income is $350,000 (congratulations on snagging this position!). Your employer will match 50% of your contribution, which can be up to 6% of your income (pretty standard). So, you contribute the full $18,000, yet that is only around 5% of your pay, which means your company match (at 50% of your contribution) will only be around 2.5% or $9,000. With a 401(k) spillover, you could contribute the full 6% of your pay ($21,000) and the company will be able to match the 50% of that contribution, a full 3% of your income, which is $10,500. You win by gaining a additional $1,500 in free money. Overall, your 401(k) funds will be $18,000 in pre tax funds and $13,500 will in a post tax portion of the account. 

Flexibility

Setting financial goals is the best way to achieve what you want in your financial life, however, you must also be flexible.

Recently, I had to raid my emergency fund for a non-emergency purpose: advanced rent of 6 months. However, because I was willing to raid my emergency fund, I believe I received a better deal from my landlord.

Also recently, I made the mathematical calculation to see if it was better to pay off my private loan aggressively or to take it slow now because I am still paying capitalized interest which counts principal and interest as interest payments for tax deduction purposes. My goal was to pay the loan down aggressively, however, after doing the math, it did not make sense until the capitalized interest was paid off.

Therefore, it is always best to be flexible if it benefits you in the long run.

My financial goals are now the following:

1. Continue to contribute up to the match to my 401(k) (4% of gross salary)
2. Make my emergency fund what it was before
3. Contribute 11% of my gross salary to my Roth IRA
4. Then think about saving extra for increased student loan payments in the future

Saving 15% for Retirement Before the Match

Here are some reasons why you should save 15% of your gross salary before the match for your 401(k) from your employer:

1. Gross, because you can adjust your withholding so that you can take a lot or very little home
2. Gross, because you don't know how much your tax return or payment will be at the end of the year and gross never changes like your take home could
3. 15% before the match so that you will get used to saving 15% even if you start working for yourself, or move to an employer that does not have a 401(k) match
4. 15% before the match because your employer's match is probably not yet vested, so don't look at it as your money
5. 15% before the match just in case you quit your job and you do loose the un-vested amount
6. 15% before the match because if your employer's money is vested, it'll be a nice bonus

Financial Clean-Up

If you haven't done so already, now is a great time to get your finances in order. Taxes are done; it's a fresh financial year. Now is a good time to start making folders for 2011 taxes: one for receipts, one for paycheck stubs, one for interest payments you make on your mortgage or student loans, etc.

If you start organizing now, taxes will be a breeze in April, or maybe you will be so organized that you can do your taxes in January and get it over with.

Now is also a good time to make some long and short term financial goals.

Here are mine:

1. Continue to contribute 15% towards retirement through 401(k) and IRA
2. Pay extra on my student loans, but just enough extra that I only pay $2,500 in interest in 2011
3. Have an emergency fund of 6 months that I don't have to touch because I have enough in checking as well (recently I pulled some money out because I had a family medical emergency, a car accident, and I want to prepay some rent to negotiate the rent down)
4. Start saving money on the side to pay off my private student loan in 2013 (as discussed in a previous post, my whole payment is currently interest because I am only paying capitalized interest and after doing some math, it works out better if I only pay $2,500/per year in interest for the tax deduction and then pay off my loan in full in 2013, when I won't be able to rack up the $2,500 in student interest payments for the tax deduction) - I would like to see $3,000 in this account by Dec 31st, 2011
5. Get a raise of around 13% from my current salary by April 2012 - currently supposed to get a raise at the end of May and then again in April
6. And of course, be able to take all my vacation days by going somewhere, buy Christmas presents for the family, and spoil my nephew-to-be

401(k) Loans and Why They are a Bad Idea

There are companies that will allow you to withdraw a loan against your 401(k) plan. It might sound like a brilliant idea for a new car or whenever you are planning to borrow money. You borrow money from yourself and pay yourself back, not a bank, with interest. Below are some things to consider.

FACTS:

1. First of all, if you need a loan, maybe you don't need to buy what you are thinking of buying. Your emergency fund should cover any real emergencies. You should save up for a car so you can buy it out right by making payments to yourself for the first 3-5 years of your auto ownership life, etc.
2. Some companies are not able to give you a loan from a 401(k).
3. Most have a minimum amount that you are required to take out such as $500-$1000.
4. If you are able to borrow, you should be allowed to borrow up to 50% of your vested balance and up to $50,000.
5. The term is generally 5 years, however, if a loan is used for a mortgage, you might be able to take out the loan for 15 years.
6. Typically, the interest rate that you pay back to yourself is prime plus 1%.
7. Payments are set up for automatic withdrawal from your paycheck.
8. There are usually loan and origination fees.

WHY IT'S A BAD IDEA:

1. There are origination and loan fees.
2. The interest that you will be paying yourself back will probably be less than the amount that you would have earned through market gains.
3. If you default on the loan, it will be counted as a distribution. Therefore, in addition to the regular taxes that you have to pay, there will be a 10% penalty fee on that amount. You also loose that money from your 401(k).
4. When you pay back the loan, you use your tax dollars to contribute to an account that should help to shelter your income. Therefore, you will be taxed twice. Once, when you repay the loan and then again when you pull that money out in retirement! Although, if you look at all of your money and not just the 401(k), you did take the loan and never paid taxes on that money, so when you are repaying the loan with taxed dollars, you are simply paying postponed tax on the the original loan amount.
5. If you quit your job or are fired, you typically have 60 days to repay your loan balance in full or the remaining balance will be considered as an early distribution causing you to be taxed on the amount. You will also have to pay a 10% penalty on the remaining unpaid loan balance.
6. The biggest factor, in my opinion, is that you cannot contribute to your 401(k) until the loan is fully repaid. This provision makes you miss out on the compounding benefits of retirement accounts and the employer match AKA free money.

Retirement vs. Emergency Fund

If you do not have a full (whatever that means according to you) emergency fund saved up, you might want to dedicate all of your funds towards the emergency fund and not save anything for retirement. However, I think there is another option that most people do not realize. Your Roth IRA can serve as a temporary emergency fund while you do not have the emergency fund build up all the way.

Most people do not say that all Roth IRA contributions are available for withdrawal anytime without taxes or penalties. Only the earnings on those contributions will incur penalties if withdrawn early. However, this is true.

Therefore, If you have an excess of $500 a month after fulfilling all your expenses and the 401(k) contribution (if it has a match). You have no emergency fund and you require an additional $300/month in retirement savings to be able to save the suggested 15% of your gross income. Instead of putting the entire $500 towards the emergency fund, put $300 in a Roth IRA and $200 in the emergency fund.

If you have a serious emergency such as a job loss or a medical accident you cannot cover, remember that you can withdraw the $300/month you have been putting in to the Roth IRA. The danger in this is that your holdings can go down. Therefore, you can hold all of your Roth IRA investments in cash until you have build up your emergency fund. The more real danger is that you will now always see your Roth IRA as an emergency fund and will empty it if an "emergency," such as a friend's wedding, arises. Don't ever take money out unless it's a real emergency. Remember that you can never replace it.

The main reason for this maneuver would be that if your emergency fund needs 8 months of expenses, then you will need a year or two to build this up. You can only contribute $5K in a Roth IRA per year and if you do not contribute one year, you miss out on that amount.

NetWorth IQ

There are several ways to track your net worth. The most convenient for me, has thus far been Mint.com because it does everything automatically. However, another way to track your net worth is through NetWorth IQ. Here are it's advantages and disadvantages.

Disadvantages:

1. You must manually enter all your data
2. All other people's data is manually entered as well and might not be accurate for comparison
3. You must enter your data every month to see the progress

Advantages:

1. You can track your net worth with a graph
2. You can see the percentage change in each category
3. You can make your net worth public so other people can comment on your progress
4. Making your net worth public might motivate you to get that number up
5. You do not need to give out personal login information
6. You can compare your net worth to others your age, or in your occupation, for example
7. You can also compare each category such as student loan debt, credit card debt, or retirement assets to others in your demographic groups

MorningStar X-Ray of Your Portfolio

If you hold several stocks or mutual funds, chances are you are not aware of the percentage of your portfolio that is in US stocks or in utilities. A great way to know the exact breakdown of what you hold by percentage is to do the MorningStar X-Ray. You can also do this before you buy an additional stock or mutual fund to make sure that you are saturating your portfolio in one type of area (unless that's what you are looking for). It's always best though - to go for diversification.

When to Start Saving for Retirement

So, you've heard people say that the sooner you start saving for retirement, the better. If you are till not saving for retirement or are not saving enough, you probably were not shown the numbers. Use this CALCXML - Savings Calculator to see how much you would loose for every year that you delay savings.

Money in your 20's

Money management skills should be learned as early as possible and the 20's is a great place to start. Here are 10 financial projects you should take on in your 20's:

1. Learn to live on less than you make. Many people who find their first job, go all out with a new wardrobe, a new car, decorations for the new apartment, etc. Control your spending and only spend what you can afford with the money you have. See the Cash Flow blog post to see how you can see your cash flow with ease.
2. Start saving. Use the budget worksheet to see where you are overspending if you are unable to spend 15% of your take home pay. If you have large student loan payments, try to cut down in all areas to free up some space for savings, even if it's $5/month.
3. If your company offers a 401(k) match, start putting in the minimum amount you have to put in to get the full match.
4. Build an emergency fund in a high interest savings account.
5. Maintain a good credit score. Make sure you are never late. Automating your bills is an easy way to make sure of this.
6. Pay down on your student loan or any other debt with any extra funds that you have. If you receive a gift, a tax refund, or a bonus, try to apply it directly to your debt. See the Debt Pay Off Methods to see how you want to tackle your debt. See how even $5 per month extra will make a difference in your debt by using the Bankrate Amortization Calculator.
7. Save for retirement. Starting early is one of the best things you can do. Use a retirement calculator to see how much you should save. Start small if you can't contribute the full amount you are advised and increase your contributions yearly.
8. Designate separate savings accounts for various goals. Retirement should be saved in a 401(k) and an IRA. You should also have separate savings accounts for an emergency fund, grad school, vacation, car, down payment, etc. You can save in each account simultaneously or take it one step at a time and once your emergency fund is full, save for a vacation, once you have enough in that account, you can save for grad school and a car, etc.
9. Get health insurance. One accident can ruin all of your plans. 
10. Earn more money. Ask for a raise at the annual review or find a job that will pay you 15%-20% more and present the offer to the current employer. Be ready to leave for the new job if the offer isn't matched.

Pay Yourself First First, No Really

Every personal finance adviser out there says to pay yourself first. There are websites dedicated to the concept. However, many of us still don't do this simplest thing. For the longest time, I figured I was disciplined enough not to have to do this. However, since I've started a couple of month ago, it has done wonders.

Paying yourself first is as simple as setting up a new savings account (if you don't have one yet) and setting up automatic transfers of at least 15% of your take home pay. It sounds so simple, but paying yourself first lets you see the money that you have left over.

Since I am saving for a couple of things right now, I have one slush fund for the 15% savings and then I distribute from there to other savings accounts based on what I feel I want to accomplish first.

This 15% is the starting point for my savings. I also contribute 4% of gross pay to a 401K and I always end up transferring more out of my checking and into my savings. However, keeping the funds separate and having the automatic savings plan of at least 15% going into my slush fund, helps keep me on track.

The Math of Retirement

There are all sorts of numbers that you can calculate to see how much you will have in retirement. The truth is no one can predict how long you will live or what your medical costs will be, for example. However, there are some numbers that you could use as estimates without having to use complicated calculators.

• Always save at least 10% of your salary for retirement
• Have at least 10 years of your final pay in retirement before you do retire
• Never withdraw more than 4% of the principle of your total holdings in retirement to make sure you don't deplete your retirement fund (this means that you should be okay with living on 4% of the total amount you have as well)

Just remember 10, 10, 4 and you should be set. 

Prioritizing Savings

If you have limited resources, you need to prioritize your savings. As discussed in the previous post, there are lots of goals you can make, but how to choose which one is more important? Here is my list:

1. build $1,000 or 3 month emergency fund (based on your gut feeling)
2. maximize your 401(k) up to the company match
3. pay off toxic debt such as credit cards or anything higher than an 8% interest rate (car, private student loans)
4. build an 8 months emergency fund
5. max out your Roth IRA
6. pay down any other debt
7. build an emergency fund of 1 year of expenses
8. invest/save for a down payment/wedding/etc.

I'm on step 4. I raided my emergency fund to put $2,000 in a Roth IRA to get the IRS credit, so I am back down to 4 months of expenses, which I can bring back up to 6 in April. Once I have 6 months, I think I will split my extra money between building an 8 month emergency fund and paying down a private student loan currently at 6.25% until I have full 8 months of an emergency fund. After my emergency savings account is fully funded, then I will pay off the student loan fully while still contributing to the IRA account so that my retirement contributions are at least $2K per year while I qualify for the retirement savings credit.

Financial Goals

The whole point of learning and keeping up with your finances is to attain our financial goals. What are your financial goals.

Here are some examples of goals:

1. Save X amount in an emergency fund
2. Save X amount of months of expenses/salary in an emergency fund
3. Save X amount for retirement this year
4. Save X% of each paycheck for retirement this year
5. Max out your IRA
6. Pay down my student loan in X amount of years
7. Pay double the minimum on my debt
8. Save for a vacation
9. Save for graduate school
10. Save for a down payment
11. Buy a car with cash

What are you saving/hoping for?  Whatever it is, my favorite tool to keep an easy track of your savings and goals is to open up a high yielding savings account (see my earlier post where to find one), and set up a goal in Mint (see an earlier post about this website as well). You can set up multiple goals as long as you have a different account for each goal and keep track of your progress. Mint will tell you if you are on track, behind, or ahead on your goals and the amount of time it will take you to reach them.

Retirement

How much should you save for retirement?

IRA maximum is $5,000 per year until you are 50 years old. Is that enough or too much? The 401(k) limit until age 50 is $14,500. You can find out what amount  you need to save by using some calculators online. There are a variety out there that will tell you what you need to save per year or what you need in total to attain your goal.

Here are some of my favorite ones:

AARP Calculator - Tells you what percentage of your income you should contribute to retire by a certain age. Also tells you the age you will retire if you keep contributing the percentage that you are currently contributing

FINRA Calculator - Shows you a schedule of exactly how much you should contribute each year. Every year, the contribution grows so that you are not overwhelmed by a large amount from the start.

CNN Money Calculator - Tells you the likelihood that you will attain your goal for retirement with a percentage. For example, "We believe there is an 80% chance, you will attain your retirement goal."


Also, you might find it helpful to see how much social security you will be getting in the future by plugging in your social security number and other info on the official SS website: Social Security Online Services. You have to have enough working credits to get the personal estimates at this website, which means that you have to have 10 years of working experience.

If you can't get your personal estimates through the website, you can estimate your future social security through the Social Security Online Services - Quick Calculator.