Tag Archives: 401 (k)

Saving Through the Ages

Guest post by Contributing Editor, Matthew Amster-Burton, Mint.com.

Saving through the agesReputable financial advisors, websites and your mom say to save for retirement, college, a down payment for a home and emergencies.

  • A typical response might be, “Yeah, but how much?” and “When?”

Libraries of books have been written on this subject. The implication is that determining your proper savings rate involves solving differential equations, brushing up on Excel functions, and reading the entire US tax code. If you’re not ready to do that, just turn everything over to an expert. Right? Not really.

Let’s talk about three things that may get in the way of people saving—and then set those obstacles aside and make it easy to do on your own, no matter your age or stage of life.

  • It’s hard. Perhaps you don’t make enough money to save aggressively or it’s psychologically difficult to set aside money instead of spending it. For most of us, it’s a combination.
  • 401(k). IRA. Roth IRA. 529 college savings plan. Savings account. Savings bonds. Why do we have so many boxes to put our money in? In three letters: the IRS. The government encourages us to save by giving us a tax break when we do.  Unfortunately, we now have so many savings vehicles to choose from that the easiest option is to just say, “I’ll think about it next month.” And we haven’t even talked about investment options yet!
  • Nobody knows the future. What if I save for college and my kid has other plans?  What if I max out my 401(k) and then need the money before I retire? Again, the easiest response is, “I’ll figure this out later.”

Pick a number

But here’s one thing to realize: choosing the wrong type of account or making a wrong guess about the future is a small mistake. Failing to save anything is a big mistake. Here are a few rules of thumb when it comes to saving through the ages.

  • If you’re young, save 25%. That’s 25% of your gross pay, before taxes. You can count debt repayment as savings, and repaying student loans should be a priority. The rest of the money can go toward a down payment fund, college fund, and retirement savings.
  • If you have kids in college, you probably can’t afford to save unless you’re exceptionally wealthy. Get your 401(k) match, avoid parent loans, and send the rest of your money to the bursar’s office.
  • If you’re 50 to 65, save 30% or more. This is the age when most people do most of their retirement savings. Tuition bills are a bad memory. The kids are out of the house. You can downsize. Plenty of families squander this opportunity. But not you, right?

These numbers are probably higher than you’ve seen elsewhere. That’s because they’re not designed for the best-case scenario. They’re designed with enough of a cushion that if everything goes right, you’ll end up with even more money that you’ll need for retirement.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

Disclosure:

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Mint.com is not affiliated with FOLIOfn or The Portfolioist.

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Am I Better Off Investing or Paying Down Debt?

Emergency Fund vs. Paying Off Debt - Which should you contribute to first?This is the fourth installment in our series on how individual investors can assess their financial health.

A common dilemma in personal finance is whether to use funds to pay down debt faster or to invest more. The question crops up in various forms:

 

  • Should I pay off all credit card debt or make smaller payments while saving more for retirement?
  • Should I pay extra on my mortgage or invest in securities?
  • Should I pay down my student loans faster or invest more?

Financial health requires both savings and control over debt. But when these two goals seem to be in conflict, what’s the best way to balance them? Consider these six ways to prioritize.

  1. Make sure you get your employer match. If you’re lucky enough to have an employer that matches your contributions to the workplace 401(k) plan, your first priority is to maximize the employer match. It’s too good to pass up. Contribute any less than what’s matched, and you’re refusing the offer of free money.
  2. Tackle costly credit card debt. Once you are saving enough to secure your entire employer match, you can focus on paying down debts faster. The goal is to pay off all credit card debt as quickly as possible. The interest rates on credit card debt are typically so high that nothing else you do with your money is likely to be as profitable.
  3. Beef up your emergency fund. When you’re beyond the hurdle of credit card debt, consider building out your emergency fund.  If you don’t have sufficient emergency savings to cover a serious car repair, a trip to the emergency room or other not-so-infrequent disasters, this is the next focus.
  4. Save enough in retirement accounts. Assuming you have no credit card debt and decent emergency savings, you can move on to the next set of priorities. If you are saving less than 10% of your pretax income in retirement accounts, ramping up your contributions is probably a better bet than paying extra on your student or auto loans or mortgage. Contributions to retirement accounts are tax advantaged, and it is almost impossible to catch up if you delay retirement savings.
  5. Decide whether to save more or pay down your mortgage. Only when you have no credit card debt, a healthy emergency fund, and you’re saving at least 10% of your pretax income should you consider making additional investments or speeding up your mortgage payments.

But when you compare the cost of having a mortgage to the possible returns from investing elsewhere, don’t forget the tax deduction on mortgage interest. Because of that deduction, your effective (after-tax) interest rate on your mortgage is lower than your actual mortgage rate. There are handy online calculators that can quickly calculate the effective interest rate on your mortgage, accounting for tax benefits.

If you are confident that you can invest at a rate of return that’s at least as high as your effective mortgage rate, you may want to hang on to the mortgage and invest more.  Over the past few years, many consumers have taken out mortgages with effective interest rates of 3% or less.  At this level of interest, there are investment alternatives that make more sense.

Also remember that extra principle payments come with liquidity risk. That is, if you need a source of cash, it may be easier to sell a security investment. To take cash out on your mortgage, you will have to refinance or open a line of credit.  Either of these may come with a higher cost than your current mortgage, not to mention origination fees.

  1. Decide whether to save more or pay down college debts. If your income is below $75,000 per year ($155,000 for a couple filing jointly), some or all of the interest that you pay on college loans may be tax deductible. So the effective rate of interest on your college loans may be lower than the actual rate. Take that into account when you compare your loan interest with potential investment earnings.

An additional consideration may be whether a parent or grandparent cosigned your student loans.  If you become disabled or die—or you’re simply unemployed for a long period of time, your consignors may have to pay your college loans.  That risk may make it worthwhile to pay off college loans faster.

Accounting for Uncertainty

If you could be sure that you’ll never lose your job and that you’ll always be able to open a low-cost line of credit, the decision to pay off debts would be much easier.  But you have to look beyond comparing interest rates on debt to the expected returns from investments. You have to consider that credit may not always be available at today’s rates.

With mortgage rates as low as they are now, paying down a mortgage does not look like the most attractive choice. Once you’ve paid off all high-cost revolving credit (e.g. credit cards), have a solid emergency fund, and you’re saving 10% of your income in retirement accounts, however, it’s worth considering paying down college debts.

Putting non-retirement money into risky investments like stocks before you have accomplished the milestones listed above makes your overall financial situation more risky.  Whether or not this is too much risk depends on you.

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Status Report on Retirement Investing: Not Good

photo: Luc Viatour

Financial Engines recently released its new study of how well American workers are doing in saving and investing for retirement.  Financial Engines has access to a sample population of 2.8 million 401(k) plan participants.  The firm analyzed these individual investors using a number of powerful metrics.

The high-level results of their findings are eye-opening:

1) 72% of plan participants are not on track to be able to comfortably retire at age 65 Continue reading

Some Target Date Funds of Funds Don’t Perform

A recently released study investigates whether target date funds are managed in the best interests of investors.  There is a substantial vein of research in the financial literature on what are referred to as ‘agency problems.’  Fund managers act as ‘agents’ for investors: they invest on behalf of the people who invest in a fund.  In theory, fund managers should want to generate the highest returns for their investors, but there are some inherent conflicts of interest—and the author of this study explains why these problems may be especially egregious with target date funds. Continue reading

Americans Face Steep Retirement Shortfall

A study released July 13 has found that nearly half of early Baby Boomers – those 56 to 62 – may not having sufficient income to pay for basic retirement expenditures and uninsured medical expenses. “Generation X” is similarly poorly positioned. Continue reading