Posted By Paul
As I did my research on annuities I found some links that I wanted to pass on:
AnnuityTruth.org - specializes in info for annuities for seniors
Ultimate Guide to Retirement: Annuities - A great page from CNNMoney with all kinds of info about the different types of annuities. A must read for anyone thinking of purchasing an annuity.
Useful info to find out more about annuities.
Showing posts with label retirement. Show all posts
Showing posts with label retirement. Show all posts
Sunday, October 18, 2009
Wednesday, October 14, 2009
What the heck is an annuity part 4: Variable with Life
Posted By Paul
This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.
This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).
So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.
What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:
1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.
2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.
I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.
To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.
So what did I learn from my brush with variable annuity/life insurance policies?
-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.
-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.
-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.
It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.
If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.
For a variable annuity/life insurance product I would suggest the following rules:
1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.
2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.
3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.
4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.
5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.
6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.
There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.
If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:
1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.
2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.
If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.
This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.
This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).
So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.
What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:
1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.
2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.
I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.
To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.
So what did I learn from my brush with variable annuity/life insurance policies?
-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.
-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.
-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.
It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.
If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.
For a variable annuity/life insurance product I would suggest the following rules:
1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.
2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.
3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.
4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.
5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.
6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.
There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.
If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:
1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.
2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.
If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.
Saturday, September 26, 2009
What the heck is an annuity part 2: fixed deferred
Posted By Paul
I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.
A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.
1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.
BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.
2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.
3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.
The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).
So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.
Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:
1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?
One interesting point is that when you compare this to my previous post:
What the heck is an annuity? Part 1
You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.
Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:
"Never invest in a business you cannot understand. "
I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.
A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.
1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.
BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.
2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.
3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.
The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).
So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.
Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:
1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?
One interesting point is that when you compare this to my previous post:
What the heck is an annuity? Part 1
You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.
Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:
"Never invest in a business you cannot understand. "
Tuesday, September 22, 2009
The 100 Rule For Investment Allocation
Posted By Paul
Have you ever heard of the '100 Rule' for asset allocation? The idea is that you subtract your age from 100 and the result is the percentage of your investments that should be in stocks (as opposed to less aggressive bond funds or the like).
Well I'd heard of it and recently decided to see if I was adhering well to that rule. Well imagine my surprise when I saw that my Vanguard fund (designed to automatically transition to more conservative funds as time goes by) wasn't even close.
A little research took me this article:
Money Savvy Rules of Thumb
Which specifically mentions the '100 Rule' (rule number 3) and says that this formula is too conservative considering the current longer lifespans of people. They suggest using a '120 Rule' which is right in line with my Vanguard fund, but unfortunately not as catchy.
Have you ever heard of the '100 Rule' for asset allocation? The idea is that you subtract your age from 100 and the result is the percentage of your investments that should be in stocks (as opposed to less aggressive bond funds or the like).
Well I'd heard of it and recently decided to see if I was adhering well to that rule. Well imagine my surprise when I saw that my Vanguard fund (designed to automatically transition to more conservative funds as time goes by) wasn't even close.
A little research took me this article:
Money Savvy Rules of Thumb
Which specifically mentions the '100 Rule' (rule number 3) and says that this formula is too conservative considering the current longer lifespans of people. They suggest using a '120 Rule' which is right in line with my Vanguard fund, but unfortunately not as catchy.
Friday, September 18, 2009
What the heck is an annuity? Part 1 - Single Premium Fixed Immediate Lifetime
Posted By Paul
As I try to become better at understanding the financial world, one word that pops up every now and then is 'annuity'.
I realized recently that I really don't have any idea what one is. I have this vague sense that I'm not interested in them, but that's not really based on anything rational, so I thought I'd do some research and share what I've found.
Here's what I've learned:
First of all, annuity is a REALLY broad term. To define it in terms that apply to all of the different flavors you end up with something like:
An annuity is an agreement (generally with an insurance company) to pay out money for a period of time.
Pretty general huh? Well it is, and that's probably why annuities get such a bad reputation, there are so many different flavors of annuity (not to mention many providers) that it's really easy to end up with a bad one.
So I'm going to start off with what I consider to be the simplest type of annuity: the single premium fixed immediate lifetime annuity.
Quite a long name, but the terms make sense if you take them individually:
Singe Premium - means there is one premium (essentially you buy it with a lump sum)
Fixed - means the payments don't vary
Immediate - means that the payments start immediately
Lifetime - means the payments continue for as long as you are alive
This type of annuity is essentially a policy that you buy with an insurance company that says that the insurance company will pay you a certain amount of money for the rest of your life.
A hypothetical example, if I were an insurance company, I might say that if you pay me $50,000 today then I will pay you $100 a month for the rest of your life.
I found a very simple web annuity quote calculator and asked it the question:
If I were age 40 (the calculator had 40 as the minimum age) and wanted an annuity that paid me $200 a month until I died, what would it cost me?
The answer? About $41k. So the question then is, is it worth it? If I just took my $41k and stuck it under the mattress and took out $200 a month, how long would that last? The quick math says I would run out of money in about 17 years. So from that calculation it seems like a pretty good deal since I plan on living longer than 17 years.
But of course if you didn't buy the annuity you probably wouldn't just put the money in your mattress, so how best to compare that?
That gets difficult, but luckily I found a savings calculator that you can use to see how long savings will last assuming a certain APR and monthly withdrawal.
If you're curious the savings calculator is here.
Using this calculator, if I start with $41k and take out $200 a month then the amount it will last depends on the APR, but for a few values comes to:
24 years at 3% interest
28.8 years at 4% interest
38.6 years at 5% interest
Interesting. At this point you start to see the trade off between having the annuity and keeping the money for yourself. Here are some of the pros and cons of the annuity:
Pros:
1) Takes some of the uncertainty out of retirement savings, with this sort of annuity you know exactly how much you'll having coming in for the rest of your life.
2) Low risk, assuming the insurance company stays solvent, you'll get your money.
Cons:
1) It's possible that you could meet or beat the returns by just managing the money yourself.
2) If you die an early and untimely death, no money is paid to beneficiaries the money is just gone (note that there ARE annuities that include a death benefit but they cost more).
3) Your lump sum is gone, so if something happens where you wanted that lump sum back, you're out of luck.
Overall, this type of annuity doesn't seem like a terrible thing from an investment standpoint, but remember, this is just ONE type of annuity, there are so many types of annuities out there that you REALLY need to be careful to make sure you're getting what you're expecting.
I'll close this (and probably all my annuity related posts) with a quote from Warren Buffett (he uses it to refer to investing it in a particular business, but I think it applies just as well to any investment vehicle):
"Never invest in a business you cannot understand. "
As I try to become better at understanding the financial world, one word that pops up every now and then is 'annuity'.
I realized recently that I really don't have any idea what one is. I have this vague sense that I'm not interested in them, but that's not really based on anything rational, so I thought I'd do some research and share what I've found.
Here's what I've learned:
First of all, annuity is a REALLY broad term. To define it in terms that apply to all of the different flavors you end up with something like:
An annuity is an agreement (generally with an insurance company) to pay out money for a period of time.
Pretty general huh? Well it is, and that's probably why annuities get such a bad reputation, there are so many different flavors of annuity (not to mention many providers) that it's really easy to end up with a bad one.
So I'm going to start off with what I consider to be the simplest type of annuity: the single premium fixed immediate lifetime annuity.
Quite a long name, but the terms make sense if you take them individually:
Singe Premium - means there is one premium (essentially you buy it with a lump sum)
Fixed - means the payments don't vary
Immediate - means that the payments start immediately
Lifetime - means the payments continue for as long as you are alive
This type of annuity is essentially a policy that you buy with an insurance company that says that the insurance company will pay you a certain amount of money for the rest of your life.
A hypothetical example, if I were an insurance company, I might say that if you pay me $50,000 today then I will pay you $100 a month for the rest of your life.
I found a very simple web annuity quote calculator and asked it the question:
If I were age 40 (the calculator had 40 as the minimum age) and wanted an annuity that paid me $200 a month until I died, what would it cost me?
The answer? About $41k. So the question then is, is it worth it? If I just took my $41k and stuck it under the mattress and took out $200 a month, how long would that last? The quick math says I would run out of money in about 17 years. So from that calculation it seems like a pretty good deal since I plan on living longer than 17 years.
But of course if you didn't buy the annuity you probably wouldn't just put the money in your mattress, so how best to compare that?
That gets difficult, but luckily I found a savings calculator that you can use to see how long savings will last assuming a certain APR and monthly withdrawal.
If you're curious the savings calculator is here.
Using this calculator, if I start with $41k and take out $200 a month then the amount it will last depends on the APR, but for a few values comes to:
24 years at 3% interest
28.8 years at 4% interest
38.6 years at 5% interest
Interesting. At this point you start to see the trade off between having the annuity and keeping the money for yourself. Here are some of the pros and cons of the annuity:
Pros:
1) Takes some of the uncertainty out of retirement savings, with this sort of annuity you know exactly how much you'll having coming in for the rest of your life.
2) Low risk, assuming the insurance company stays solvent, you'll get your money.
Cons:
1) It's possible that you could meet or beat the returns by just managing the money yourself.
2) If you die an early and untimely death, no money is paid to beneficiaries the money is just gone (note that there ARE annuities that include a death benefit but they cost more).
3) Your lump sum is gone, so if something happens where you wanted that lump sum back, you're out of luck.
Overall, this type of annuity doesn't seem like a terrible thing from an investment standpoint, but remember, this is just ONE type of annuity, there are so many types of annuities out there that you REALLY need to be careful to make sure you're getting what you're expecting.
I'll close this (and probably all my annuity related posts) with a quote from Warren Buffett (he uses it to refer to investing it in a particular business, but I think it applies just as well to any investment vehicle):
"Never invest in a business you cannot understand. "
Thursday, August 20, 2009
Cool Info About the Roth
Posted By Paul
I read an article that made a point about the Roth that I thought was interesting.
For those of you not familiar with the Roth IRA you can read up on some earlier posts on this topic:
Roth IRA: A tax shelter for your golden years
-and-
The Roth as a College Savings Vehicle
I put money in a Roth with the basic idea that the more money I can save towards retirement the better. The article made the additional point that any money you put into a tax-deferred retirement account (like a 401k or IRA where you pay taxes when you take it out, presumably during retirement) has the added wrinkle that you really have no idea what the tax laws will be like when you retire.
The changes in the tax rates for a particular income bracket can have a dramatic effect on your retirement situation. Let's say theoretically that when you retire the tax rates are much lower...well then your retirement money will go that much farther and the opposite situation if tax rates end up being much higher.
When talking about a retirement that is probably decades away, it's VERY hard (perhaps impossible) to predict and plan for this.
However, the Roth sidesteps all this. You pay the taxes now so you don't have to worry about what the tax laws will be in the future.
Not to say you should dump your IRA or 401k, but I thought it was a cool little point about the Roth that hadn't occurred to me.
Here is the full article:
New Ways to shelter your retirement
I read an article that made a point about the Roth that I thought was interesting.
For those of you not familiar with the Roth IRA you can read up on some earlier posts on this topic:
Roth IRA: A tax shelter for your golden years
-and-
The Roth as a College Savings Vehicle
I put money in a Roth with the basic idea that the more money I can save towards retirement the better. The article made the additional point that any money you put into a tax-deferred retirement account (like a 401k or IRA where you pay taxes when you take it out, presumably during retirement) has the added wrinkle that you really have no idea what the tax laws will be like when you retire.
The changes in the tax rates for a particular income bracket can have a dramatic effect on your retirement situation. Let's say theoretically that when you retire the tax rates are much lower...well then your retirement money will go that much farther and the opposite situation if tax rates end up being much higher.
When talking about a retirement that is probably decades away, it's VERY hard (perhaps impossible) to predict and plan for this.
However, the Roth sidesteps all this. You pay the taxes now so you don't have to worry about what the tax laws will be in the future.
Not to say you should dump your IRA or 401k, but I thought it was a cool little point about the Roth that hadn't occurred to me.
Here is the full article:
New Ways to shelter your retirement
Sunday, October 19, 2008
Is Your Money Where It Should Be?
Posted By Paul
If I can find any silver lining in the current crazy economic times it is the fact that it has provided me with a reminder that I need to be careful about where my money is.
Here are some examples I've been hearing about where people learned lessons by the current fall in the market:
1) I have friends who were hoping to retire soon, but their nest egg was in very aggressive funds. When the stock market dropped, their nest egg shrunk, so now they need to postpone retirement until they can afford it.
2) I have other friends who have a 529 college savings plan for their child. Their child will be off to college soon so they were surprised when their college savings shrunk dramatically right when they were hoping to use it.
3) As I have mentioned in earlier posts, I keep part of my "rainy day fund" in what I view as pretty conservative stocks. Though conservative, these equities are still part of the stock market and they have not been immune to the recent drops.
It's one thing to fill out questionnaires about 'risk tolerance' and quite another to actually watch your investment shrink day after day.
So here are some things that I've been looking at as I do a risk tolerance gut-check for my investments.
1) For retirement funds, I'm where I should be. Sure it's hard to watch the balance of my retirement accounts fall, but I am going to try to keep in mind that it's not like I have plans to access that money any time soon. I need to think long term. One way to make sure that your investments match your retirement timeline is to use a target date retirement fund. Another choice is to periodically view and re-evaluate where your money is relative to your retirement timeline.
2) As a new father I've been looking into 529 savings plans. I noticed that the 529 plan that I'm looking into has a target date fund as well. You give it the expected years until college and it transitions the contents of the funds to less aggressive investments as the years go by. I plan on trying this as a way to make sure that my risk tapers off as we get closer to the time where we'll need the money.
3) There was a great comment on a previous post: Economic Chaos: So Now What? The comment was that it wasn't a very good idea to count securities as part of my rainy day fund. I can't argue with the sense that the whole point of a rainy day fund is to have money available at a moment's notice when you need it, which means that you should have it in a very low risk investment. So I'm going to stop viewing my stocks as part of my rainy day fund, and instead I'm going to work on increasing my rainy day fund by adding to my savings account and CD's. I'm going to keep my stocks because they are still doing fine for me, I'm just not going to count them as part of my rainy day fund.
So hopefully no one out there has been burned too badly by the stock market drop, but if nothing else this drop has been a great object lesson on making sure that your investments REALLY match your risk tolerance.
If I can find any silver lining in the current crazy economic times it is the fact that it has provided me with a reminder that I need to be careful about where my money is.
Here are some examples I've been hearing about where people learned lessons by the current fall in the market:
1) I have friends who were hoping to retire soon, but their nest egg was in very aggressive funds. When the stock market dropped, their nest egg shrunk, so now they need to postpone retirement until they can afford it.
2) I have other friends who have a 529 college savings plan for their child. Their child will be off to college soon so they were surprised when their college savings shrunk dramatically right when they were hoping to use it.
3) As I have mentioned in earlier posts, I keep part of my "rainy day fund" in what I view as pretty conservative stocks. Though conservative, these equities are still part of the stock market and they have not been immune to the recent drops.
It's one thing to fill out questionnaires about 'risk tolerance' and quite another to actually watch your investment shrink day after day.
So here are some things that I've been looking at as I do a risk tolerance gut-check for my investments.
1) For retirement funds, I'm where I should be. Sure it's hard to watch the balance of my retirement accounts fall, but I am going to try to keep in mind that it's not like I have plans to access that money any time soon. I need to think long term. One way to make sure that your investments match your retirement timeline is to use a target date retirement fund. Another choice is to periodically view and re-evaluate where your money is relative to your retirement timeline.
2) As a new father I've been looking into 529 savings plans. I noticed that the 529 plan that I'm looking into has a target date fund as well. You give it the expected years until college and it transitions the contents of the funds to less aggressive investments as the years go by. I plan on trying this as a way to make sure that my risk tapers off as we get closer to the time where we'll need the money.
3) There was a great comment on a previous post: Economic Chaos: So Now What? The comment was that it wasn't a very good idea to count securities as part of my rainy day fund. I can't argue with the sense that the whole point of a rainy day fund is to have money available at a moment's notice when you need it, which means that you should have it in a very low risk investment. So I'm going to stop viewing my stocks as part of my rainy day fund, and instead I'm going to work on increasing my rainy day fund by adding to my savings account and CD's. I'm going to keep my stocks because they are still doing fine for me, I'm just not going to count them as part of my rainy day fund.
So hopefully no one out there has been burned too badly by the stock market drop, but if nothing else this drop has been a great object lesson on making sure that your investments REALLY match your risk tolerance.
Saturday, October 4, 2008
Article: Retirement Planning For Mom and Dad
Posted By Paul
An interesting article on the often touchy subject of dealing with the retirement status of your parents:
Retirement planning for mom and dad.
Tuesday, September 30, 2008
Article: Don't let the crisis spook your 401k
Posted By Paul
An article where the author (Walter Updegrave, Money Magazine senior editor) explains why he thinks that you shouldn't let the current economic crisis keep you from investing in your 401k:
Don't let the crisis spook your 401k
The whole article is worth a read, but here are a few specific excerpts:
"In fact, I think it would be a mistake for virtually anyone, regardless of age, to forego saving for retirement in a 401(k) or similar account in reaction to the recent failures, takeovers, freefalls in stock prices, etc."
"I believe that the best way to deal with the inherent uncertainty of investment markets is to settle on an asset allocation that makes sense for you and, aside from rebalancing back to it once a year, pretty much leave it alone (or at least refrain from making big changes)."
An article where the author (Walter Updegrave, Money Magazine senior editor) explains why he thinks that you shouldn't let the current economic crisis keep you from investing in your 401k:
Don't let the crisis spook your 401k
The whole article is worth a read, but here are a few specific excerpts:
"In fact, I think it would be a mistake for virtually anyone, regardless of age, to forego saving for retirement in a 401(k) or similar account in reaction to the recent failures, takeovers, freefalls in stock prices, etc."
"I believe that the best way to deal with the inherent uncertainty of investment markets is to settle on an asset allocation that makes sense for you and, aside from rebalancing back to it once a year, pretty much leave it alone (or at least refrain from making big changes)."
Monday, March 3, 2008
Pay raises and budget adjusting
Posted by Matt
I had my annual review recently and received the happy news that I would be receiving a 4% pay increase. Yippee. So I'm almost keeping pace with inflation. Okay, attitude adjustment...be thankful for what I have and get on with the info.
My family was getting along fine before my "bump", so I decided that we could just stick with that same income level. One of my financial goals for 2008 is to increase my savings rate anyway (especially for retirement), so I signed on to our H.R. website and increased my 401k contribution level from 15% to 19%. (For the detail-oriented among you, yes, I'm aware that contributing 4% of my new salary is going to cost slightly more than I actually get from a raise that is 4% of my old salary, but I figured I should stretch.) This should put me very close to maximizing my 401k contribution this year! Finally!
I just found out that my company automatically monitors my contribution level and if I do ever exceed the maximum, they will make the excess contributions from after-tax dollars to save me from having to take a distribution. The after-tax contributions can be withdrawn tax-free (since I've already paid tax on them, obviously), however, the growth on after-tax amounts is taxed.
Seems like yet another argument to open a Roth account, but I'm still holding out. Maybe I should work on exceeding the income limit so that I can just forget about them once and for all. How's that for a goal?!
For any of our readers that our interested in the benefits of my 20/20 hindsight, I wish I would have accelerated my savings rate faster than I did. Increasing the contribution rate when you get a raise is the least painful way I know of to do it; I probably just wasn't aggressive enough with the size of the increases.
Friday, January 4, 2008
Article: Capital Ideas
Posted By Paul
Wow, what an odd coincidence. The article that Matt just posted about was also sent to me by my sister and I wrote a similar "how I stack up versus the rules" article, I thought it would be cool to have both of our articles, so here is mine:
My sister sent me this article recently that I thought was interesting:
Capital Ideas
I thought the article was really interesting since it gave some guidelines for where you should be financially. I thought I would summarize the guidelines in the article and see how I'm doing relative to them.
"$10,000 is now about the average credit-card debt per household, according to cardtrak.com."
How Am I Doing?
I'm doing great here, credit card debt is 0.
"At 30, you should have your highest levels of debt (including mortgage, student loans and credit cards) to earnings, with total debt double your annual earnings. As you age, that figure should get smaller, and stay below 1:8. At the age of 45, debts should equal your annual salary."
How Am I Doing?
Since I'm sort of half way between 30 and 45, so I guess following the guideline would imply that I should have about 1.5 times my annual salary in debt. Assuming that since I'm married I should consider total household salary, then my calculations say that my debt to income ratio is almost exactly 1:1, so it sounds like I'm a bit ahead of schedule there.
"You should also aim to be saving 12 percent of your income annually, and the savings you amass should exceed your annual income in your 30s, says Farrell. By the time you are 40, you should have 1.7 times your income stashed away for retirement, and by 50, aim for three times your earnings."
How Am I Doing?
My wife and I actually save more like 15-20 percent of our salaries. It says that by the time you are 40 you should have 1.7 times your income stashed away for retirement. Currently my wife and I have about 1.85 times our salary in retirement accounts, so it looks like we're ahead of schedule there.
"Lenders (at least the sensible ones) like to see borrowers keep their housing expenses—including mortgage payments, insurance and property taxes—to 28 percent of gross income."
How Am I Doing?
I think a rough estimate is that our total mortgage, insurance and property taxes are about 10% of our gross income.
It looks like according to this article my wife and I are living a pretty savings heavy lifestyle. It looks like we're ahead of schedule as far as our savings and that our cash flow situation looks pretty good.
In fact my stats would look even better if the stock market hadn't taken such a beating in the last month or so.
Wow, what an odd coincidence. The article that Matt just posted about was also sent to me by my sister and I wrote a similar "how I stack up versus the rules" article, I thought it would be cool to have both of our articles, so here is mine:
My sister sent me this article recently that I thought was interesting:
Capital Ideas
I thought the article was really interesting since it gave some guidelines for where you should be financially. I thought I would summarize the guidelines in the article and see how I'm doing relative to them.
"$10,000 is now about the average credit-card debt per household, according to cardtrak.com."
How Am I Doing?
I'm doing great here, credit card debt is 0.
"At 30, you should have your highest levels of debt (including mortgage, student loans and credit cards) to earnings, with total debt double your annual earnings. As you age, that figure should get smaller, and stay below 1:8. At the age of 45, debts should equal your annual salary."
How Am I Doing?
Since I'm sort of half way between 30 and 45, so I guess following the guideline would imply that I should have about 1.5 times my annual salary in debt. Assuming that since I'm married I should consider total household salary, then my calculations say that my debt to income ratio is almost exactly 1:1, so it sounds like I'm a bit ahead of schedule there.
"You should also aim to be saving 12 percent of your income annually, and the savings you amass should exceed your annual income in your 30s, says Farrell. By the time you are 40, you should have 1.7 times your income stashed away for retirement, and by 50, aim for three times your earnings."
How Am I Doing?
My wife and I actually save more like 15-20 percent of our salaries. It says that by the time you are 40 you should have 1.7 times your income stashed away for retirement. Currently my wife and I have about 1.85 times our salary in retirement accounts, so it looks like we're ahead of schedule there.
"Lenders (at least the sensible ones) like to see borrowers keep their housing expenses—including mortgage payments, insurance and property taxes—to 28 percent of gross income."
How Am I Doing?
I think a rough estimate is that our total mortgage, insurance and property taxes are about 10% of our gross income.
It looks like according to this article my wife and I are living a pretty savings heavy lifestyle. It looks like we're ahead of schedule as far as our savings and that our cash flow situation looks pretty good.
In fact my stats would look even better if the stock market hadn't taken such a beating in the last month or so.
Wednesday, January 2, 2008
Article: Retirement Plan Interrupted
Posted By Paul
An interesting article on CNN Money about how stretching your housing expenses too far can put you in a tight situation:
Retirement Plan Interrupted.
An interesting article on CNN Money about how stretching your housing expenses too far can put you in a tight situation:
Retirement Plan Interrupted.
Thursday, December 13, 2007
If I'm self-employed, am I still eligible to retire?
Posted by Matt
The answer is yes, but don't take my word for it as I'm NOT self-employed. I've heard the question from a few people, though, so I thought I would share a link out to another blogger who wrote on the topic of self-employed 401k's.
The 401k is obviously not your only sound retirement account option, but if your business is doing well enough, you may max out the contribution limits on other tax-advantaged account types (i.e., Roth IRAs).Friday, November 16, 2007
What Is A Target Date Retirement Fund?
Posted By Paul
A fairly new feature on the mutual fund landscape is a create called the 'Target Date Retirement Fund'.
What is it? Well the idea behind it is that if you're investing for retirement you should invest in more aggressive and risky investments when retirement is far off, but as you approach retirement you should start to move your money into more conservative funds so that a sudden drop in the market doesn't hurt your nest egg right when you need to start using it.
Generally what people do is something where in their 20's and 30's they focus on the more aggressive mutual funds, then in their 40's they move into the more moderately aggressive funds, and then as people start to approach retirement age they move into the less risky funds.
If it's such a simple process then why can't it be done for you? Well that's what a Target Date Retirement Fund is. So let's say you plan to retire in 30 years, then the idea is that you could buy a Target Date Retirement fund that is targeted to that timeline (these sorts of funds generally have names like 'Target Retirement in 2035') then sit back and let the fund manager handle allocating your investments and gradually transitioning it to more conservative investments as time goes on.
I am intrigued by this idea since it seems about as close to a 'set it and forget it' fund as possible. In fact one of our Roth IRA's is in a Target Date Retirement Fund. If nothing else it seems like a simple place to put your money until you decide if you want to put it elsewhere.
One thing I have read that you need to be careful about is to not take too much advantage of the 'set it and forget it' mentality. Specifically if you have such a fund, check it periodically to see where the investments are. Perhaps the fund managers opinion of 'acceptable risk' when your 10 years away from retirement is different from yours.
A nice thing with these funds is the fact that you can change your risk levels by changing funds. For example, let's say that you plan to retire in 30 years so you put your money into a 'Target Retirement in 2040' fund. You then decide that this fund has more risk in it than you'd prefer, and you're willing to give up potential returns in favor of less fluctuations in your fund. You can move some or all of that money instead into a 'Target Retirement in 2035' fund. The fund manager doesn't care if you actually plan to retire by the target date or not, and by making this move you've transitioned your investments further along in the transition from aggressive to conservative.
I am quite new to Target Date Retirement Funds but I think I'm going to look into them more closely. My hope is that I can use these Target Date funds to create a gradual transition from risky to conservative investments while also moving between funds to fine-tune the risk tolerance more closely.
A fairly new feature on the mutual fund landscape is a create called the 'Target Date Retirement Fund'.
What is it? Well the idea behind it is that if you're investing for retirement you should invest in more aggressive and risky investments when retirement is far off, but as you approach retirement you should start to move your money into more conservative funds so that a sudden drop in the market doesn't hurt your nest egg right when you need to start using it.
Generally what people do is something where in their 20's and 30's they focus on the more aggressive mutual funds, then in their 40's they move into the more moderately aggressive funds, and then as people start to approach retirement age they move into the less risky funds.
If it's such a simple process then why can't it be done for you? Well that's what a Target Date Retirement Fund is. So let's say you plan to retire in 30 years, then the idea is that you could buy a Target Date Retirement fund that is targeted to that timeline (these sorts of funds generally have names like 'Target Retirement in 2035') then sit back and let the fund manager handle allocating your investments and gradually transitioning it to more conservative investments as time goes on.
I am intrigued by this idea since it seems about as close to a 'set it and forget it' fund as possible. In fact one of our Roth IRA's is in a Target Date Retirement Fund. If nothing else it seems like a simple place to put your money until you decide if you want to put it elsewhere.
One thing I have read that you need to be careful about is to not take too much advantage of the 'set it and forget it' mentality. Specifically if you have such a fund, check it periodically to see where the investments are. Perhaps the fund managers opinion of 'acceptable risk' when your 10 years away from retirement is different from yours.
A nice thing with these funds is the fact that you can change your risk levels by changing funds. For example, let's say that you plan to retire in 30 years so you put your money into a 'Target Retirement in 2040' fund. You then decide that this fund has more risk in it than you'd prefer, and you're willing to give up potential returns in favor of less fluctuations in your fund. You can move some or all of that money instead into a 'Target Retirement in 2035' fund. The fund manager doesn't care if you actually plan to retire by the target date or not, and by making this move you've transitioned your investments further along in the transition from aggressive to conservative.
I am quite new to Target Date Retirement Funds but I think I'm going to look into them more closely. My hope is that I can use these Target Date funds to create a gradual transition from risky to conservative investments while also moving between funds to fine-tune the risk tolerance more closely.
Friday, November 2, 2007
Millionaire Next Door Review Pt. 2: UAW or PAW
Posted By Paul
Part 2 of my ongoing review of this great book. The book mentions this interesting little calculation to determine your wealth accumulation status. The authors believe that financial independence is not just about income, it's about increasing your wealth, and that wealth accumulation goals need to relate to your income.
Essentially they're saying: "Try to save and invest as much as you can, and the more money you make, the more you should be able to save and invest."
So they use this simple calculation:
1) Take your total income
2) Multiply that by your age
3) Divide that total by 10.
Your answer is what they suggest should be your net worth. If you are significantly below that number then you are an Under Accumulator Of Wealth (UAW). If you are significantly above that number then you are a Prodigious Accumulator Of Wealth (PAW).
Of course I think back to what this calculation would have been at various times in my life, and it falls apart a little. For example, when I was 22 and had my first job, I was making a salary but my networth was negative (since I had a car loan, student loans and hadn't started saving at all), so I would be considered a dangerous UAW, but these are probably edge cases that get lost in any 'rule of thumb' calculation.
Anyway, take a second and calculate out what the authors consider to be your target net worth (so far the book doesn't say way what to do if you're married, I would suggest using total household income in step 1, and average age in step 2), and see if you're on track by their standards or if you're a UAW or a PAW.
Part 2 of my ongoing review of this great book. The book mentions this interesting little calculation to determine your wealth accumulation status. The authors believe that financial independence is not just about income, it's about increasing your wealth, and that wealth accumulation goals need to relate to your income.
Essentially they're saying: "Try to save and invest as much as you can, and the more money you make, the more you should be able to save and invest."
So they use this simple calculation:
1) Take your total income
2) Multiply that by your age
3) Divide that total by 10.
Your answer is what they suggest should be your net worth. If you are significantly below that number then you are an Under Accumulator Of Wealth (UAW). If you are significantly above that number then you are a Prodigious Accumulator Of Wealth (PAW).
Of course I think back to what this calculation would have been at various times in my life, and it falls apart a little. For example, when I was 22 and had my first job, I was making a salary but my networth was negative (since I had a car loan, student loans and hadn't started saving at all), so I would be considered a dangerous UAW, but these are probably edge cases that get lost in any 'rule of thumb' calculation.
Anyway, take a second and calculate out what the authors consider to be your target net worth (so far the book doesn't say way what to do if you're married, I would suggest using total household income in step 1, and average age in step 2), and see if you're on track by their standards or if you're a UAW or a PAW.
Thursday, October 25, 2007
Roth IRA reversal
Posted by Matt
Paul and I have both posted several times about the advantages of using the Roth IRA to save for retirement, and I still believe in it for all the same reasons. BUT, after much consideration, I've decided that I'm not going to open one (for 2007, at least). How's that for a ringing endorsement?
I do want to increase my retirement saving rate, however, and I've elected to increase my 401k contribution rate from 12% to 15%. That still won't put me at the maximum contribution, but every little bit helps. Here's why I went this way:
So, I'm just trying to do the best I can. I don't think anyone would argue that I shouldn't put more money into my 401k account. They might make a compelling argument that it's not the BEST place for it, but who can say for sure?
Paul and I have both posted several times about the advantages of using the Roth IRA to save for retirement, and I still believe in it for all the same reasons. BUT, after much consideration, I've decided that I'm not going to open one (for 2007, at least). How's that for a ringing endorsement?
I do want to increase my retirement saving rate, however, and I've elected to increase my 401k contribution rate from 12% to 15%. That still won't put me at the maximum contribution, but every little bit helps. Here's why I went this way:
- I like the fact that the 401k withdrawal is totally automatic and almost invisible to me. Yes, I see the money come out each paycheck, but I don't really feel it. It's just another line item on the pay stub. The money that I really think about and budget with is the amount that actually gets deposited in my checking account.
- Yes, I could have set up automatic withdrawals for the Roth, but I don't like to have any more accounts than is necessary. It's probably just a personality thing. In my dream world, I would have a single bank account that somehow encompassed all of my finances. I remember one point when my wife and I were still figuring out how to handle our joint finances and we had about nine different checking and saving accounts. It just didn't feel right.
- Finally, the Roth's benefits aren't that compelling FOR ME. Yes, it is nice that the principal is available for emergency withdrawal, but that is what I have an emergency fund for. Yes, it would be nice if some of my income was tax-free in retirement, assuming that I'm in a higher tax bracket then, but who knows if I will be?
What will my salary be each year?The list goes on and on. Remember the computer in the movie "War Games" that ran through every possible nuclear war simulation and determined that the only way to ensure a positive outcome was to not engage in war at all? Well, I've gone through lots of scenarios and the only thing I was able to determine for certain is that I should definitely save for retirement. Shocking.
What tax bracket will I be in during retirement?
What will happen to the tax laws?
So, I'm just trying to do the best I can. I don't think anyone would argue that I shouldn't put more money into my 401k account. They might make a compelling argument that it's not the BEST place for it, but who can say for sure?
Monday, October 15, 2007
Article: Dumb Retirement Moves
Posted By Paul
An interesting article listing "9 Ways To Ruin Your Retirement"
http://www.bankrate.com/dls/news/retirement/20071009_dumb_retirement_moves_a1.asp
An interesting article listing "9 Ways To Ruin Your Retirement"
http://www.bankrate.com/dls/news/retirement/20071009_dumb_retirement_moves_a1.asp
Wednesday, October 10, 2007
Article: 13 Retirement Myths
An interesting article on CNN Money today listed 13 Retirement Myths.
http://money.cnn.com/galleries/2007/moneymag/0710/gallery.retirement_myths.moneymag/index.html
http://money.cnn.com/galleries/2007/moneymag/0710/gallery.retirement_myths.moneymag/index.html
Tuesday, October 9, 2007
Not Everyone Can Contribute To A Roth
Posted By Paul
There have been several posts about Roth IRA's ("The Roth as a College Savings Vehicle", "How sure are you that your child will go to college?", "The Roth IRA: A tax shelter for your golden years.") and there is all kinds of info out there about the annual contribution limits, but many articles don't even mention that unless you meet certain criteria you're not eligible to contribute to a Roth IRA.
I went on a hunt to find the specific criteria for contributing to a Roth IRA. I wanted to get the info from the source so I went directly the IRS web page.
The problem with that is that the IRS has very little information at your fingertips via their web page. My experience has been that the IRS web page just lets you access their forms and info booklets via pdf's, which I guess is better than nothing, and probably much simpler for the IRS to maintain.
So for the actual info on the criteria for contributing to a Roth IRA, you can look at the publication located here:
http://www.irs.gov/pub/irs-pdf/p590.pdf
(hopefully this link will remain valid for a while)
If you go to page 58 you can see a pretty decent table that summarizes the conditions for contributing to a Roth IRA.
Here is some basic info I can summarize:
-If you're single and your modified adjusted gross income is less than $95,000 you can contribute the full amount to a Roth.
-If you're filing jointly and your modified adjusted gross income less than $150,000 you can contribute the full amount to a Roth.
-If you're married and filing separately and your modified adjusted gross income is $0 then you can contribute the full amount to a Roth.
If you're anywhere near the borderline where you might not be eligible to contribute the full amount to a Roth IRA, I suggest you read the latest publication (and you might want to ask an accountant to confirm). Tax laws are confusing and often defy simplification.
There have been several posts about Roth IRA's ("The Roth as a College Savings Vehicle", "How sure are you that your child will go to college?", "The Roth IRA: A tax shelter for your golden years.") and there is all kinds of info out there about the annual contribution limits, but many articles don't even mention that unless you meet certain criteria you're not eligible to contribute to a Roth IRA.
I went on a hunt to find the specific criteria for contributing to a Roth IRA. I wanted to get the info from the source so I went directly the IRS web page.
The problem with that is that the IRS has very little information at your fingertips via their web page. My experience has been that the IRS web page just lets you access their forms and info booklets via pdf's, which I guess is better than nothing, and probably much simpler for the IRS to maintain.
So for the actual info on the criteria for contributing to a Roth IRA, you can look at the publication located here:
http://www.irs.gov/pub/irs-pdf/p590.pdf
(hopefully this link will remain valid for a while)
If you go to page 58 you can see a pretty decent table that summarizes the conditions for contributing to a Roth IRA.
Here is some basic info I can summarize:
-If you're single and your modified adjusted gross income is less than $95,000 you can contribute the full amount to a Roth.
-If you're filing jointly and your modified adjusted gross income less than $150,000 you can contribute the full amount to a Roth.
-If you're married and filing separately and your modified adjusted gross income is $0 then you can contribute the full amount to a Roth.
If you're anywhere near the borderline where you might not be eligible to contribute the full amount to a Roth IRA, I suggest you read the latest publication (and you might want to ask an accountant to confirm). Tax laws are confusing and often defy simplification.
Wednesday, September 12, 2007
The Roth as a College Savings Vehicle
Posted By Paul
There are many options out there when it comes to saving for college. I had heard that some people use a Roth IRA as a college savings vehicle and this idea intrigued me.
The article Matt wrote already outlines the basics of the Roth IRA. So I was interested in how this applies to college savings.
So with a Roth you put post-tax dollars into an account and earnings that you make are tax free. You can withdraw your contributions at any time for any reason without taxes or penalty, but if you withdraw earnings early (before age 59 1/2) then you pay a 10% penalty tax AND you have to pay taxes on the earnings.
So how does this become a college savings vehicle? Well the answer is that if you withdraw earnings early and use them for higher education expenses then you avoid the 10% penalty tax but you still have to pay taxes on the earnings.
One reason this appeals to people is because the Roth sort of provides a savings vehicle that can be used to save for a child's college, but also can serve as something else.
For example, if you save all of this money in a Roth, but then out of nowhere your grandparents offer to pay for your child's college education (this is a VERY hypothetical case for most people) your Roth can still serve as your retirement account.
Another cool trick is that you can use your Roth as a combined college savings and retirement account. Let's say for example that you reach a point where you decide you can save $500 per year for college and another $1500 for retirement. You can take the whole $2000 and put it into a Roth IRA.
So now fast forward to the future. Let's say that over the years your $2000 became $3000. That means that the $1500 for retirement has grown to $2250 and the $500 has grown to $750.
Now you decide that you want to take some money out for college expenses. If you can take out the $750, and as far as the IRS is concerned you're still taking out less than the total money you have contributed, so this money is yours, tax free and penalty free.
There is a great article on college savings through the Roth here. The idea of using a Roth for college savings is interesting, but I think I'm going to keep looking around. I plan on researching (and posting articles) about other options in the future.
There are many options out there when it comes to saving for college. I had heard that some people use a Roth IRA as a college savings vehicle and this idea intrigued me.
The article Matt wrote already outlines the basics of the Roth IRA. So I was interested in how this applies to college savings.
So with a Roth you put post-tax dollars into an account and earnings that you make are tax free. You can withdraw your contributions at any time for any reason without taxes or penalty, but if you withdraw earnings early (before age 59 1/2) then you pay a 10% penalty tax AND you have to pay taxes on the earnings.
So how does this become a college savings vehicle? Well the answer is that if you withdraw earnings early and use them for higher education expenses then you avoid the 10% penalty tax but you still have to pay taxes on the earnings.
One reason this appeals to people is because the Roth sort of provides a savings vehicle that can be used to save for a child's college, but also can serve as something else.
For example, if you save all of this money in a Roth, but then out of nowhere your grandparents offer to pay for your child's college education (this is a VERY hypothetical case for most people) your Roth can still serve as your retirement account.
Another cool trick is that you can use your Roth as a combined college savings and retirement account. Let's say for example that you reach a point where you decide you can save $500 per year for college and another $1500 for retirement. You can take the whole $2000 and put it into a Roth IRA.
So now fast forward to the future. Let's say that over the years your $2000 became $3000. That means that the $1500 for retirement has grown to $2250 and the $500 has grown to $750.
Now you decide that you want to take some money out for college expenses. If you can take out the $750, and as far as the IRS is concerned you're still taking out less than the total money you have contributed, so this money is yours, tax free and penalty free.
There is a great article on college savings through the Roth here. The idea of using a Roth for college savings is interesting, but I think I'm going to keep looking around. I plan on researching (and posting articles) about other options in the future.
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