Tag Archives: 401k

Investing

So My Employer Over Contributed to My 401k – Now What?

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Although I had the idea last year to contribute enough for my 2017 401k to obtain the match my company provides, I decided against it since I didn’t want to mess anything up w/ my taxes.

Fast forward a few months and I notice something strange when my Fidelity 401k shows a contribution on Jan 2. This clearly came out of my final 2017 paycheck. I looked at my paycheck and confirmed this — my employer made my contribution in 2017, even though I told them not to start contributing to 2018. Continue reading So My Employer Over Contributed to My 401k – Now What? →

Investing, Retirement

Are 401k Accounts a Scam?

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I’m no financial expert, but I try to follow the basic principles of investing and retirement savings in order to hopefully not be dirt poor in old age. One of these principles has been to consistently max out my 401(k) each year, which I’ve done faithfully now for many years, ever since I finally had access to a retirement account at work. As soon as as started making too much money for a Roth IRA, I socked away $18k a year in my 401k… and now, between all my pre- and post-tax retirement accounts, I have about $235k locked away, compounding over time.

However, after reading more propaganda on 401k investing, I started to suspect something fishy is up. Most of the anti 401k content focuses on issues with high fees — which, indeed, are a big problem with 401ks. But, really, the most suspicious piece of messaging out there on the benefits of the 401k is that you don’t have to pay taxes now so you get the “benefit” of paying them later. Continue reading Are 401k Accounts a Scam? →

Class & Wealth, Retirement

A Brief History of Retirement and the Social Security Crisis

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Ah… retirement. That time in life when you’ve worked hard for long enough to “deserve” time to sit back and relax – maybe play some golf, or take classes to reignite an old hobby, or travel the world. Today retirement is so engrained in our culture as a natural phase of life that it’s easy to forget that it is a very modern concept.

In 1881, Otto von Bismark, a conservative minister president of Prussia, came up with an idea to have older adults not have to work to the very last second of their lives. Eight years later the German government started to provide a retirement system for anyone over the age of 70. At the time, not many people made it that long.

Across the Atlantic in the US, retirement was a fledgling idea. Municipal employees started to receipt public pensions in the mid 1800s and in 1975 American Express started to offer private pensions. It wasn’t until 1935 when the Social Security act passed and the official retirement age in the US was 65. (Life expectancy for men was 58 at the time.) Continue reading A Brief History of Retirement and the Social Security Crisis →

Family, Retirement, Wealth

My Parents Are Actually Not That Great with Money

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When I grew up I knew two things to be fact – my dad was talented at earning money and my mom was equally talented at spending it. My mother constantly complained about us not having a lot of nice things – and we indeed were upper middle class and not a millimeter over the upper class line – but we had it rather great. As my father worked a professional job requiring his math brain, the money kept rolling in. And my mom (and I) would keep spending it.

But despite the “every time we come back from the mall” fights on spending it never was  a “real” issue. We weren’t in danger of losing the house. My private college tuition was paid for outright. So was my sister’s private school for a learning disability and then college. Apparently at some point my father’s company was sold and he did fairly well for himself in his stock and income appreciation. My parents should be comfortably set for life and then some.

However my father (who was told he had two years to live about nine years ago, mind you) and my mother have spent and spent and spent post “earning” years and with the stock market underperforming all his estimates about his finances didn’t quite pan out. Shocking for a man who made a career out of calculating risk. Yet, here we are today, with my father looking at all the numbers involved in the family finances and he can’t make heads or tails of it. There’s a massive home equity loan out that has to be paid back fairly soon, and there’s little left on it to borrow at this point anyway. He wanted to spend a lot on my wedding but, now that I better understand their financial situation – I realize it was not a good idea. It’s not that they are broke – they have social security and pension money coming in… about $100k a year. But in order to afford not only my wedding but also a winter condo they bought in the southeast and renovations to that condo and fixing a bunch of things breaking around their main house there is the reality that my dad had to pull out a bunch of money from the IRA bumping him up into a higher tax bracket so most of the income they’re making goes to taxes.

So they have to in the next few years pay back about $200k in home equity. How? The idea seems to be either from a reverse mortgage (which as I learn more about I really don’t like) or taking more money out of the IRA and paying a lot of taxes on it or, well, there aren’t many other options. The money is there, but it isn’t. They’re so much more fortunate than most people their age (due to smart saving at least and the possibility of a one-working-parent household being able to afford a nice life and a decent retirement) but their spending is just out of control. It’s not just my wedding – which theoretically my father had budgeted “forever” for – it’s the lack of acceptance of 1 – what life really costs and 2 – what their life really costs.

My father keeps talking about how they’re going to have to “get frugal” and I can’t help but laugh. They aren’t exactly going on luxury vacations but my parents do spend. My mother has no concept of money and I worry she’s going to eventually spend every last cent of her retirement money leaving her with “just” the monthly income – which at some point may not be enough to pay for her care. I’ll help, of course, as much as I can – but I’m stuck in the reality of my world which = I cannot ever afford a house, I cannot figure out how to save enough for my own/my family’s retirement, even on my current substantial income (which will not last because I’m about to completely crack in my current career and my next step is something less profitable but more personally fulfilling, I hope) – in any case, I’ll need to help out of guilt knowing how much my own life has cost them, but it’s still frustrating that this didn’t have to happen… they were doing so well and then they had to put an addition on the house and had to buy too-nice further for the vacation property and had to get a new dress for every wedding-related event coming up (I’m glad I talked my mother out of purchasing a $2000 dress for my wedding when the $300 dress she got looked WAY better than the one the fancy store was trying to sell her.)

I just worry too because I know that in so many years my father’s cancer will eventually end his life (I hope this is a long time out but who knows) and my mother will – god willing – life a very long time. But as bad with money and gullible as she is she’s suceptable to all sorts of scams and con arts and just about any potential way for her money to disappear. My dad likes to talk to me (so awkwardly) about how he wants my sister and I to get an inheritance – and I can’t comment on that because on and hand I think inheritances are just plain awful and unfair and should not be allowed and on the other hand the world we live in is one where people can or can not afford to, say, buy a house or send their kids to college due to such mini dynasties. It’s not a topic I’m comfortable talking about and I certainly don’t want to be the person held responsible for convincing my mom not to, you know, spend that money that one day would possibly end up trickling down to me and my sister – even though I honestly don’t want it if she needs to spend it, I just don’t want to see her getting conned. I worry I’ll have to be the responsible one because my sister knows nothing about money and clearly I’m the best educated on the topic (I don’t know how that happened but anyway, it happened.)

My father was even asking my advice on how to repay the home equity. I have no idea. $200 is a lot of money. It took me a very long time to save $200. Now I have almost double that. But it’s all locked up in retirement funds and such. It’s about half of the cost of their actual house. I don’t understand home ownership and the whole taking loans out against your property. It seems like he has a really great rate (2 percent?) so maybe that’s a smart/good thing. But it’s only smart insofar as the needed to spend the money. It’s my wedding but it’s more than that for sure. It’s just this nature of spending and spending and spending and being delusional slash not wanting to deal with the time to come when they really do need to be “frugal” in their own middle class sort of way… not something my mother has known how to do for years. I worry they’ll lose their home – though my father said that will never happen – but I’m starting to doubt his ability to predict these things. He seems rather surprised about how much taxes he owes in general and how things add up and money keeps disappearing. He seems perplexed that the stock market didn’t perform strongly so his networth shrunk more than expected and he didn’t have a backup plan to deal with this. And this all has led me to the conclusion that my father – the math guy – the financial industry risk expert – is actually really bad with personal finances. I worry for them, and I also hope somehow I can do better with my own family and wealth. I’m beginning to think that all starts with NOT owning property – EVER. Rent is expensive but at least it’s not handcuffs.

Career, Family, Investing, Networth, Parenting & Motherhood, Wealth

November Networth Check-In and Retirement Update

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Now that I am “in between incomes,” so to speak, I am re-focusing my objectives for total assets this year, and beginning planning for 2016 based on my potential earnings at my new opportunities.

As a reminder, my goal was to close out 2015 with $400,000 in net worth. That figure was always a stretch, but it isn’t going to happen this year. My new goal is to wrap up the year with at least $350,000 in net worth, which is about a 15% increase in my nest egg – not bad but not great either. My goal is to give birth to my first child in the summer of 2017, when I’m about to turn 34 (yikes.) That means getting pregnant in the fall of 2016 or soon after would be ideal. That means that I still want to aim for $500k in net worth by the time I have my first kid (let’s call that July of 2017.) This is about 19 months to increase my net worth by $150k.

Let’s start with where I am today — according to www.networthIQ.com my current net worth is $380,783. I will subtract my car ($8000) and stock options that will soon be worth nothing from that ($16,000) to what is my “actual” net worth — so about $356k. I’m also losing money now since unemployment doesn’t cover my monthly expenditures, so assuming the stock market does decently this month and I land a new job for December start (which is looking quite likely) I should be able to close out the year about $350k. A reminder, in January of 2009 I had about $5k to my name (see graph below.)

november net worth

In order to hit my goal of saving $150k in 18 months (assuming ending 2015 with $350k), I need to “save” $8333 per month. How is THAT going to happen?

If I (knock on wood)  increase my income levels in my next job to $190k (which is super exciting and feels like too much yet if the market will pay that for my services, I’ll take it!), that is a take-home of about $9400 a month (which is a lot and really starts making this dream possible – this is where it gets exciting!) Even with my average spending of about $3500 a month,  I will have $5900 per month to put away. But this also, theoretically, is two years of 401k investment, which I can max out each year. So that’s $36,000 of the total $150k right there (assuming I can keep my job and do well at it!) Ok, so one opportunity has a 3% match of your salary on that, which is awesome (I’ve NEVER had a 401k match in my entire career!) That means each year I’d make an extra ~$5700 just for putting the money in my 401k (if I’m understanding the match thing correctly.) So that is $11,400 on top of the $36k. Ok, so that takes care of $47,400 of the $150,000, and leaves a slightly more realistic $102.6k left to save over 18 months, or, $5700 per month. Income is reduced a bit with the 401k investment, of course, by $18000 a year – but that’s all pre-tax. But with bonus, etc, it should balance out to still taking home somewhere around $9k a month, or maybe a little less. That’s still a lot for the short-term goal.

Now, let’s assume my stock portfolio / the market increases by an average of 5% each year. It could be less and it could be more, but let’s say 2% – 5%. That is somewhere between $7000 and $17500 for year one, and a max of $20.9k in year two (at 5%), minimum of $8368 (for the entire year, but I’ll count that in these numbers since even if I’m not working my portfolio will continue to gain interest.) Ok, so on the more conservative end with just a 2% year-over-year gain, I’ll have another $15,368 covered by investment interest…

$150,000 goal
$36,000 = 401k investment
$11,400 = 401k match @ 3% of income
$15,368 = portfolio interest at 2% YoY
———————————————
$87,232 to save in 18 months, or,
$4846 per month

This is very doable, as long as I select a job where I can stay a minimum of 18 months. One opportunity does not have 401k match, so I am leaning toward the one that does, since this clearly helps substantially in reaching my long-standing goal of $500k by childbirth.

Once I have kids, I am expecting to work part-time and see my annual savings levels decrease. Of course, I’ll have a husband who is also working, but he doesn’t earn as much as I do or invest his savings beyond a Roth IRA (which he’ll no longer be eligible for once we’re married – yeay marriage.) We’re not really combining incomes when we’re married – just continuing to split major household expenses. We’ll probably start to split a little more… right now we just split rent (I pay more since I make more) and food (we spend way too much on food for two people) — but in the future when we’re married I can see us splitting healthcare expenses, and maybe things like gas/transit. When we have a kid all those expenses will be split too. Luckily I have a penchant for household accounting. What a great hobby!

Seriously, though, if I can get to $500k before I have a kid, this frees me up so much from this looming fear of the future I have. It’s not exactly a nest egg that will make me rich, but it’s a very good start to be at $500k by 34. The goal was by 30 but so what… goals are meant to be hard to reach, but they keep you focused on getting to where you need to be.

With $500k, if I can manage to not touch that money until I’m 65, at an annual return of 5%, that gets me to about $2M in retirement (not counting any future earnings or my husband’s earnings/savings. At a 10% YoY return that’s about $8.7M in retirement. Heck, if that grows at 10% YoY in 20 years once hitting $500k, that will be worth $3.3M – not exactly placing me in the .01%, but certainly providing enough income for early retirement / starting my own business / doing what I want when I’m 55 years old. I know a lot of women in their early 50s and I can see this age being a good time to have that flexibility. You’re still healthy enough to trade and have fun, your kids are old enough to appreciate spending time with you (hopefully) and overall if you’ve been smart about saving over the years, you can take a moment to actually enjoy life.

So when people read this blog and comment about how this $500k goal is so silly, well, it really isn’t.

The MOST important thing right now for all of this is picking a job where I can stay stable at for the next 19 months, at a minimum. That’s a long time and I’m going to take it month by month and focus on being so productive my employer couldn’t even dream of replacing me. 18 months is just 6 quarters, and that will go fast, especially if I’m pregnant for half of them!

I really hope I can do it. I’ve come so far. This seems within reach. Having my first kid at 33/34 is not ideal, I’m going to have to have my second at 36 and if I want a third, well, that’s going to have to be pretty much right away after that. This leaves me little time to keep earning at the same rate, especially in my field, where having kids doesn’t seem to align with the amount of hours required to work. I have to make the money now, so I can leave the options open for the future.

 

 

 

 

 

 

 

 

Investing, Retirement

Question for my Readers: Should I do a Roth IRA conversion?

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One of my biggest financial mistakes to date was rolling over my 401k – or at least, I think it was. By rolling over my 401k accounts I made a Roth IRA conversion of my post-tax “traditional IRAs” unwise. There is, however, a way go around my mistake in order to convert my post tax IRA accounts to a Roth. I’m just not sure if it makes sense to do this. In lieu of hiring a CFA, I pose this question to my readers: should I convert (by doing the following) or not?

The Data

I currently have $14,803 in a post-tax IRA (i.e., I thought I was ineligible for a Roth for two years, at which time I funded a post-tax IRA. This was probably a mistake to begin with, but nonetheless, I have $14,803 in the post-tax IRA. I’d like to convert it to a Roth.)

Where did this money come from?

2010 – $5000 contribution
2011 – $5000 contribution

Thus, I currently have $4,803 in unrealized gains in this account.

If I were to convert to a Roth I would have to pay taxes on this… which maybe not worth it to begin with. However, even if that would be worth it, I have another IRA account from my Rollover 401k. If I were to convert to a Roth I would not only have to pay tax on the $4803, but I’d also have to pay income taxes on the entirety of my 401k account (or a percentage of it, depending on the total conversion.)

The catch is — it is possible to rollover my prior 401k and current IRA account into my new work 401k. At least it looks like it’s possible to do this. By doing this I would no longer have an additional IRA so I’d be able to rollover my post-tax IRA into a Roth IRA and pay tax on “just” the $4803 in gains (or whatever it is at the time I do the conversion.)

However… the funds I have access to in my work 401k are not nearly as compelling as those I have access to in my Vanguard IRA. At the moment, most of my investments in this IRA have a .10 expense ratio. My employer 401k options seem to be mostly in the 1.10 expense ratio, with one S&P fund at .54 or something like that. So, ultimately, I would need to do the math to figure out if it would make any sense to bother with all this hassle to convert my two years of traditional IRA investing to a Roth. I’m really not even sure if I wasn’t eligible for a Roth at the time, but I’m pretty sure it’s too late to fix this error if it was an error. Hmm.

My thoughts are as follows:

1) Wait until the last minute to rollover my current IRA into my work 401k. The last minute mean whenever in the future I am about to leave my company, or, in the case of being laid off, filing the paperwork on the day I’m laid off.

2) If that works, I’d wait until the rollover cleared, and I no longer had an existing IRA beyond the Sharebuilder 2010/2011 contributed-to account.

3) Then I wait… until a year when my income is low (probably when I have my first child or when/if I go to grad school, though this is all a hypothetical time/year to begin with – and needs to happen before I get married!)… and convert the existing post-tax funds to a Roth, so my tax rate is low.

4) That said, does it really matter? In 35 years the account will be worth $415,916 if it makes 10% in interest per year. So I’d have to pay tax in retirement on $405,916. Or, I figure out how to do the conversion in the near future and pay tax now on $5000, give or take. I’m not sure if the tax comes out of the account or you can pay that separately, assuming you can pay it separately then I’d still have $15k or so to compound over the years for retirement, and just pay $2500 or whatever it is right now in taxes on the conversion – if I can actually rollover my old 401k IRA into my new 401k.

But… then I need to look at how much is lost due to the higher expense ratios in the 401k account on the $91k-ish that is in my current IRA. If I have to pay 1% more per year in expenses then…

According to this calculator, if I left my $91k in the new 401k for 5 years, paying an additional 1.00% in expenses each year, with a 10% YoY rate of return, the total fees would be $7885.21, including operating fees and opportunity costs, versus $731.32 if I left it alone in my Vanguard account w/ the .10% expense ratio. So, basically, for the five years waiting for a year when I don’t make that much money (assuming I don’t actually get married) then I’d lose $7500 or so waiting to convert the existing post-tax IRA to a Roth, plus I’d lose whatever tax I’d pay on the gains on the interest gained in the post-tax account. So I’d end up probably paying $10k now in order to avoid paying tax on my hypothetical $405k in retirement.

That seems like a fair trade, if it actually worked out. I’m sure there’s a catch somewhere, I just don’t know enough about finances to see it. That’s why I’m asking my readers…  should I rollover my $91k IRA to my 401k in order to convert my $15k post-tax IRA to a Roth?

 

 

 

 

Budget

Getting my Finances in Order – End of Year Edition

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I understand why the rich have personal CFAs to help them manage their finances. Trying to do this properly and have a 24/7 full-time job is a bit chaotic… I can’t imagine making sense of this with kids to boot. For now I have a few free hours each week to make sure I’m keeping on budget, investing the right amount towards my retirement, and paying off bills so I don’t generate any nasty late fees or dings to my credit.

At the moment, the big question is when to pay for what. I’d like to hire a CFA to help me understand this, but think that any savings I see via the CFAs advice would be washed out and then some via the CFAs fee. If someone is super rich then whatever a CFA charges will not be more than their savings gained via the outside expertise, but when we’re taking tens or hundreds of dollars it’s unclear to me if there’s value in bringing in outside help. I really want to make myself an expert so I can make the best choices, but that, again, is not possible with a full-time job.

Right now the biggest question is December spending. I typically play my cards to save up a chunk of cash at the end of each calendar year so I can splurge, so to speak, on my 401k in the first months of the next year. I never have faith I can keep my job for the entirety of the year (the reality of startup life) nor do I have faith my next position will have access to a 401k. There are also various reasons why investing earlier in the year is better vs later, though a lot depends on the stock market performance (i.e. if stock market is sucking at end of previous year then odds are it will start to go up at some point so investing early is important, vs if stocks are performing well like they are now and a downward run seems more likely, so dollar cost averaging over the course of the year is the better way to go.) (*this is my theory and not validated in any shape or form.)

The other open question is how much to put towards my Roth IRA this year. I’m going to be on the line where my contributions are reduced, but I’m really not clear by how much because I’ve held so many different jobs this year – not to mention have dividends and stock sales coming from multiple accounts – and I haven’t done a good job in keeping track of my total earnings. This is where I’m confused as to whether I should just max out my Roth IRA and then deal with recharacterizing before Oct 15, 2015 (and likely have to hire a CFA for this) or just stay well under the limit and accept I’ll probably miss out on some future tax savings (though at my income level who knows if Roth IRAs really hold any value anyway.)

I’m also questioning what to do with my $600 doctor’s bill because I’m waiting for my COBRA to kick in (I sent in paperwork but apparently did it wrong so had to re-send it in.) The actual COBRA costs $800 for the two months so now I’m wondering if I should just pay the bill and have a lapse in coverage – need to do more research into how bad that actually is. I have insurance now through work, but I would be facing the lapse if I don’t legally backdate the COBRA with that $800 payment, which is only $200 or so more than what I owe anyway…

Meanwhile I owe my boyfriend a good $12,000 because he’s been paying my chunk of the rent over the last year. I only don’t feel bad about that because he has most of his money sitting in a checking account (talk about risk adverse) and I’m investing this loan and will pay him back slowly. Given how much it will cost us to buy a house every dollar matters and having thousands of dollars sitting in a bank. At least last year I convinced him to start a Roth IRA.

You know, these are all first world problems but they’re problems nonetheless. I’m going to create a new post to go live tomorrow on how I’m going to manage this mess of my December 2014 finances.

Investing, Retirement

Understanding the Roth IRA Conversion Pro Rata Rule & a Great Trick!

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IRAs come in two flavors — traditional and roth. Both have income and contribution limits per year in order to take advantage of their benefits. Roth IRAs require that you pay taxes up front on any income you put into them, but then — this is where the magic happens — your interest grows tax free forever. You can take the total amount out at retirement and not pay any tax on it! You can also pass the total amount onto your heirs without them having to pay taxes. It’s a pretty spectacular deal, especially when you’re in a very low income bracket so you aren’t paying much in the form of taxes up front.

Traditional IRAs, on the other hand, are available for low income earners, often who do not have access to a 401k. With the traditional IRA one would put their money in and not pay taxes on this money up front, but then when they retire and take the money out it’s taxed as income for that year (theoretically your tax bracket would be lower in retirement, but this may not be true.)

Up until recently if you made too much money for an IRA you really couldn’t do anything other than invest in taxable accounts. Traditional IRAs were available but you weren’t able to take the tax deduction up front or when you took the money out in retirement, so the only benefit there was the years of dividends not being taxed and reinvested into your investments. It’s not even that great of a deal because then you’re paying income tax rates on your dividend yields versus dividend rates. Generally traditional IRAs for high income earners are useless.

However for tax benefits, today a higher income earner can do a little trick called a Roth IRA conversion. This occurs when the individual puts up to the year’s limit in a traditional IRA ($5500 currently)  and then immediately converts that to a Roth IRA. Because the individual put in post-tax money and the conversion happened right away, no taxes are owed and basically that higher income individual has gone through a loophole to invest in a Roth. For younger folks in their 20s and 30s the ongoing compound interest and ultimate ability to take out the investments tax free might be better (do your own math to figure out if this makes sense for you.)

The trouble comes when you have multiple IRA accounts. Most often this is from 401k rollovers when you leave a job. A 401k is pre-tax money so if you want to roll that over to a Roth you will have to pay tax on not only the interest earned but also the entire amount of basis. That can be an expensive proposition!

That is where the “pro rata” rule comes in. Understanding how this works is a bit challenging. I’ll try to explain this in simple terms based on my research so it’s accurate and makes sense.

How the Roth IRA Conversion Pro Rata Rule works

At the end of the tax year (not the day you do the conversion) the government will look at all your non-Roth IRA funds to determine how much tax you need to pay. They aren’t nice enough to let you get away without paying taxes on a conversion when there is tax money they could make. Instead they require you to pay pro rata on the amount you convert.

Let’s take an example very near and dear to my heart (so I can finally understand what sort of tax liability I’m looking at here.)

I would like to convert my current IRAs to Roth IRAs before rolling over my high-fee 401k (*or I need to get a new job with a better 401k as I can rollover my 401k to that so I can continue to do Roth conversions year after year.)

Vanguard IRA (from rollover 401k)

$26,987 (all pre-tax)

Sharebuilder IRA

$14,027.47 ($10k is post-tax, $4027.47 is pre-tax)

Due to the pro-rata rule it is not possible for me to rollover just the $10k of post-tax money today.

If I rollover the $10,000 of post-tax money, the pro-rata rule would take my total amount of IRA money $41014.47 to determine how much I actually owe.

To figure this out for yourself, follow the steps listed here.

1. Total up all of your IRAs (non Roth): $41,014.47
2. Total up all of your after-tax dollars in IRAs: $10000
3. Calculate your % of after-tax dollars: 24.38%
4. Determine the taxable amount of your distribution: ($20,000 distributed = $4876 tax free, $15124 taxable(!))
5. Exception for rollovers to a company plan: n/a

…

In order to take out the full $10,000 of post-tax money, I’d have to convert the entire amount ($41,014.47) and pay taxes on $31,014.47.

…

Is either scenario worth it? Let’s play this out to the conclusions…

Assumptions:

  • 35 years growth
  • .05% average interest rate
  • 30% federal and 10% state tax in retirement (40% taxes)

1. I do nothing, and leave my $41,014.47 to grow for 35 years until I turn 65 and retire.

  • $226,235 pre-tax
  • Total Value = $135,741 (@40% tax bracket)
  • ((15% tax bracket, in 0% income tax state, low annual withdrawals, would = $192,229))

2. I convert 25% of my IRA plans today

  • Pay tax on $15,124 at today’s tax rates (28% fed, 10% state – $5747.12 in tax)
  • Have $14252.88 remaining to grow tax free forever
  • $78,619 post-tax on conversion
  • + $116068 * 40% tax = $69640
  • Total Value = $148,260

3. Just for kicks, I convert 100% of my IRA today, paying tax on $31,014.47

  • Pay tax on $31,014.47 at 38% rate — $11785.50 in tax paid today
  • $29228.97 remaining to growth tax free forever
  • Total Value = $161,227

4. Additional test thrown in — low income year, 25% tax today

  • Pay tax on $31,014.47 at 25% rate — $7753.61
  • $33260.86 remaining to grow tax free forever
  • Total Value = $183,467

…

What do these calculations teach us?

  • The value of a Roth Conversion (if you have both deductible and non-deductible IRAs) is determined largely by your current tax rate and your expected tax rate in retirement (oh fun, guessing games.) Apparently people tend to overestimate how much taxes they will pay in retirement (i.e. maybe my 40% estimate is too high. You think?)
  • The conversion for an account that looks like mine MAY make sense if I can hold it for 35 years or longer. But it’s still not a sure bet. (I calculated everything at a 5% return YoY to be conservative.)

When Does the Roth Conversion Not Make Sense?

I haven’t done all of the calculations, but I assume at some age the roth conversions do not make sense UNLESS you have no taxable money to deal with. If you don’t have many years for the interest to compound and make up for what you paid in tax, then you’ve just paid a lot of money to the government to make less in the end. That’s what they want you to do. That’s what a lot of people who aren’t running the numbers are going to do thanks to this new rule.

When Does the Roth Conversion Make a Lot of Sense?

If you have one year of your life where you happen to not be making a lot of money — maybe it’s a year you went to school or took time off to have a kid — you will be able to do the conversion and pay your income tax on that conversion. If you are single and have no income, your first $36,900 of taxable conversion (or mix of conversion amount and income) is taxed at just 15% (the first $9600 at 10%.) This changes the numbers quite a bit! So say you want to convert $20k with $10k of it non taxable and $10k taxable. You pay $1k on the first $9600 and 15% on the $400 ($60) so you’d pay just $1060 to convert your $20k, leaving you with $18940 to grow tax free forever — if you live in a no income tax state, anyway (most states will charge you income tax so factor this into your calculations as well.) That’s still a pretty great deal, but you’re also losing all of the money you could have made that year and put into your investment accounts, so it’s not worth it to do this unless you are already planning to take the time off. (And if you really want to be tricky move to a state with no income tax and don’t work for a year!)

(Note, married couples can stay in the 15% tax bracket up to $73,800 income including the taxable IRA conversion amount.)

The Best Trick I’ve Found (That is legal, at least for now)

If you have a work-sponsored 401k, find out if it allows you to “reverse rollover” pre-tax IRA investments. If you can do this, take all of your pre-tax IRA investments and move them into your 401k. You will have to keep those investments in the 401k until you change jobs again (and at least for a year) so if the 401k offers crappy, high-fee, high-load mutual funds you’re going to want to run all the numbers in your specific situation. That said, if you have a decent 401k and can rollover your funds into it — you can roll them over and then only pay taxes on  your interest on any post-tax IRA contributions for the Roth conversion. This means that you can save a lot of money and do a few years of IRA conversions to grow your roth (esp if you are a high income earner and are already maxing out your 401k.)

Now that I’ve figured out this is do-able, I’ve immediately decided to rollover my existing crap high-fee 401k into my Vanguard low-fee, no-load Admiral funds IRA account. I’ll let those babies grow until I have a nice 401k at a future job (knock on wood) that lets me roll over my IRA for a while, and I’ll convert at least the $14k of traditional IRA investment plus probably another $5.5k for the current plan year. I will have to run the numbers myself at the time but I think this is probably the best idea.

Even if that doesn’t work out, the actual growth on my pre-tax accounts will still be beneficial and perhaps my actual tax rate in retirement won’t be quite as high as I think it will be. It still might be best just to leave these accounts alone and continue putting $5.5k in a Roth every year that I’m eligible, whether I’m in school and working part-time or unemployed and unexpectedly coming in within the income limits to contribute to a Roth.

Have anything else to add? Think I don’t explain this well?

Leave a comment with your tips and ideas for when a Roth IRA conversion makes sense, and when it doesn’t. Did I get something wrong here? Let me know. Thanks!

 

Investing, Retirement

Should I Rollover My 401k? The Cons

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Common financial sense says that you should rollover your 401k into an IRA account as soon as you leave a job. Besides keeping all your financial accounts in one place (so you don’t have a bunch of orphan 401k accounts floating around), fees on typical 401k accounts are painfully expensive (remember in our last post we discussed how after 30 years on a $100k investment every .10 increase in percentage points will cost over $50,000 in fees.)

However, there are some lesser known reasons why you should leave your 401k where it is, at least for the short term.

1. Penalty-Free Retirement at 55 vs 59

The government isn’t ok with you withdrawing funds from your IRA before 59 1/2, but for some reason you’re allowed to withdraw from your 401k at 55. This doesn’t make any rational sense but government rules never do (source)

2. Roth Conversions Get Much More Expensive After a Rollover

A few years ago the government made another rule that doesn’t make any sense — you’re not allowed to contribute to a Roth IRA (i.e. after-tax money that you can take out for free in retirement and that you can pass on to heirs tax free) BUT you are allowed to put money in a traditional IRA, post-tax, and immediately convert this to a Roth IRA tax free. (Did I mention the government makes NO FREAKING SENSE?) However, if you have additional IRA funds, especially ones you haven’t paid tax on yet, you have to pay a pro-rata fee for the percentage you want to convert. I’m going to write a separate post about this pro-rata rule because it’s so complicated I don’t even understand it yet, but basically once you have more funds in traditional IRAs you’re liable for tax on part of them as well if you want to do a Roth conversion, and this can be very expensive and eat into your future earnings (source)

3. Better Creditor Protection

In yet another rule that makes no sense (notice a trend here) 401ks are protected more than IRAs in the case of lawsuits and such. How screwed you are in the case of a personal liability lawsuit depends on what state you live in. For example, New Hampshire and New Mexico have no protection against creditors for your IRA, whereas your 401k can’t be touched. (Say it with me now – this doesn’t make any freaking sense!) In some states, such as Texas, Arizona and Washington, your IRA is treated with the same protection of a 401k , so this rule wouldn’t apply to you (source)

4. Fees Can Be Lower (Though This is Unlikely)

Often the 401k offers access to different funds then you would have access to as an average investor. A lot of articles argue that you could be better off staying with a 401k funds… but make sure to look into the fees of these funds. Mutual funds can cost 1.4% per year or .80%, but those are still high fees compared to a basic Vanguard fund at .10% to .25%. Ask yourself if you really think this fund will perform better than an index fund (hint – it probably won’t, or at least not enough to make up for lost earnings due to fees) (source)

Can you think of any other reasons to keep your 401k at your old employer? #2 and #3 seem to be the best arguments. Tomorrow I’ll share a post that further explains Roth conversions – because they confuse the heck out of me so I need to do some better research, and I’ll share my findings with all of you!

Economy, Retirement

OMG: 36% of Americans Have NO Retirement Savings

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The concept of “retirement” always seemed a bit funny to me — after all, why save up all of your recreational time for the years when your body is expediting its rate of decomposition? Retirement wasn’t always a thing just as engagement rings were not always a thing (read a good recap of how retirement came to be on The New York Times.)

It turns out that when you’re older, keeping your mind and body busy with work can help you live longer (no really, it’s proven that retirement has a detrimental effect on health in old age.) Research from the Institute of Economic Affairs and the Age Endeavor Fellowship found that both mental and physical health can suffer — increasing the likelihood of clinical depression by 40% and having a diagnosed physical condition by 60%. That said, not everyone has the luxury of working until they kick the bucket, even if they wanted to, and even if it would be better for them statistically speaking. Between disabilities caused by your body slowly falling apart and the fact that many employers just don’t like old people, most employees stop work well in advance of the time their soul peaces out.

For “us millennials” we have this opportunity to determine what we want in our retirement or non-retirements, to at the least have a choice that many boomers now don’t have because of the great recession. Continue reading OMG: 36% of Americans Have NO Retirement Savings →