Relief for Retirement

Good news, the 401(k) match is back!  According to Chavon Sutton at CNN Money, 80% of the companies that suspended or reduced their 401(k) programs are planning to restore them this year.  When many companies stopped their 401(k) match programs last year, I suggested that people stop contributing to their 401(k) accounts and instead start investing elsewhere, such as by opening a Roth IRA account.  But now that they are back, if you’re given the option, jump back into the game and start contributing to your 401(k) accounts again.  Click here to find out why the match is such a great benefit offered by companies and why you can’t afford not to match.  If you have had to scale back on saving for retirement or have simply never been able to save because more urgent matters keep cropping up, this is the perfect incentive to start.

Saving for Retirement through a Credit Card? Not So Fast.

Two weeks ago, the WSJ published an article on credit cards that offer cash back or points that can be used to fund your retirement or another investment account.  As the article explains:

Instead of redeeming earned points for the typical airline tickets or gift cards, users of these cards receive cash that they can then deposit into an individual retirement account or another investment or savings account.

This seems like a reasonable deal, and may in fact be useful to those who need some help remembering to move some of their savings into their retirement account.  But beware of the conditions and reward rates.  Here, we review the cards mentioned in the WSJ article:

  • Ameriprise: Ameriprise has 5 credit cards – 2 for only members of its Achiever Circle Elite program.  Its rewards program is like many others, awarding one point per dollar spent on most purchases (and varying bonuses depending on the card).  Points can then be redeemed for a range of things, including travel, gift cards, and funding into an Ameriprise account, including savings and investment accounts.  Points for funding Ameriprise accounts can only be redeemed in increments of 10,000, which are converted into $150 – effectively, a 1.5% reward return.  Two of the cards have no annual fee, while the fees for the other three cards range from $125 to $450 after the first year.
  • Edward Jones: The rewards program for the Edward Jones Personal Credit Card is very similar to Ameriprise’s, offering a variety of options for which points can be redeemed.  One of them is funding into an Edward Jones account, such as an IRA or 529.  However, points can also be redeemed for cash at exactly the same point exchange rate.  For example, for 2,500 points, you can get either $12.50 in your account or as a cash reward check, and for 50,000 points, you can get $500 in either form too.  The reward rate is also relatively low, as it ranges from 0.5% when redeeming 2,500 points to just 1% for redeeming 50,000 points.  There is no annual fee for this card.
  • Fidelity Investments: Fidelity offers 4 different credit cards, all of which transfer your rewards straight into your Fidelity account.  There are 3 American Express options, which post 2% of the value of your purchases into a Fidelity Investment, IRA, or 529 accounts, respectively.  The Visa card, on the other hand, gives only 1.5% on the first $15,000 you spend per year on the card, and 2% thereafter.  All 4 cards do not have annual fees.

The WSJ article also warns about interest rates, but even readers who pay their balances in full every month should think carefully before signing up for one of these retirement or investment cards.  These cards require that rewards be deposited into an account opened at their respective financial  institutions.  Further, their reward rates are quite low, and you are likely better off getting a good cash back card – such as Discover or CitiForward – and, if you want, depositing some or all of your returns into an investment account or IRA of your choice.

Tax-Deferred Plans for the Self-Employed: sometimes it is nice just knowing you have the option

In general, we believe that, if your employer does not match your contributions to a 401(k), a Roth IRA is a better option.  It can move with you as you switch employers and grows tax-free.  Whether you are employed or self-employed, you may open and contribute to a Roth IRA as long as you have an income and your MAGI is below $120,000 if you are single or $176,000 if married and filing jointly.  But if you are self-employed, you should know that you are not barred from having a 401(k) as well, just like individuals with employers – you have the option of having a tax-deferred retirement plan though a SEP IRA or a Keogh plan.

SEP IRAs and Keogh plans are designed for small businesses, and for the self-employed they work basically the same way.  You can set them up through a financial institution, and your maximum contribution depends on your net earnings through self-employment.  As your contributions will be tax-deferred, you may deduct a portion of them in your income taxes using a worksheet that considers your income as well as the deduction you already get for your self-employment tax (check out the IRS publication 590 to learn more ).

While a Roth IRA may be easier to set up and manage, knowing that you can also have a 401(k) as a self-employed individual may nonetheless come in handy if you make or expect to make more than the income limit for contribution to a Roth IRA, or if you would like to contribute more to retirement than the $5,000 allowed under the IRA plans.

Rollover – Not in Your Bed, But to a Roth IRA

With less than three weeks of work left, my calendar is quickly filling up with farewell lunches.  I have not, however, neglected other more important things related to my departure, such as making sure I will get paid for unused vacation days and that my calculation is the same as HR’s.  ALSO, I have been researching on what to do with my 401k once I leave, and below is a list of dos and don’ts.

  1. Do not withdraw  – Apparently one of the biggest mistakes that people make when they leave a job is to withdraw the money from their 401k.  Not only will you be making a HUGE dent to your retirement funds, you will be paying heavily for it – income tax for the distribution plus an additional 10% tax  (the IRS says tax, I say penalty) for withdrawing before you hit the magic age of 59 1/2.
  2. Do not just leave it in its current account – Now is the time to assess how well the account has been growing.  Do you like the investment options offered by your company and the investment company they have selected?  Are you satisfied with the services?  If not, you are free to take your business elsewhere, whether to one you select individually or another 401k account offered by your new job.
  3. Do roll it over – If you do decide to transfer your 401k to a new account, do a rollover.  Once a check gets cut to you – even if you deposit it directly into a new retirement account – the IRS will consider that a withdrawal and you’ll be hit with the income tax and the 10% penalty.  It’s better to play it safe and arrange for a direct transfer, so that no money passes through your hands.
  4. Do consider a Roth IRA – As mentioned in previous posts, you contribute post-tax dollars to a Roth IRA but it then grows tax-free.  This is what I plan to do with my 401k account.  And while I’ll get hit with taxes in the beginning (because I contributed only pre-tax dollars to my 401k initially and Uncle Sam always gets his cut), I will never have to pay taxes on any subsequent earnings.  This is crucial, because I expect that I will earn more money as I get older and will be taxed at a higher tax bracket.  So this is not just a matter of paying taxes now vs. paying taxes later, it’s also a matter of paying less taxes now vs. paying more taxes later.  Further, I’m not required to roll over the entire balance at once.  I can control how much I want to roll over each year, so I can spread out my tax burden over several years.

IRA for the Independent

From the response we got to yesterday’s post on contributing to a Roth IRA if your employer does not offer matching contributions to your 401K, we realized it’s time for a back-to-basics crash course on IRAs.  This is also a timely issue, as the increase in the number of self-employed, unemployed, and underemployed people due to the economic downturn means that many more people who used to rely on automatic transfers into their 401Ks will have to set up and learn to manage IRAs instead.

So here are the basics:

“IRA” stands for “individual retirement account,” and there are at least four types of them.  The less common SEP IRA and SIMPLE IRA may be available through your employer and involve making contributions straight from your paycheck.  The two more popular ones, and most relevant for the self-employed, however, are the traditional IRA and Roth IRA.  The main difference between them is when they are taxed: contributions to a traditional IRA can be deducted from your income tax (i.e., the contributions are tax-free) but you pay income tax on them when you withdraw them later in life; in contrast, contributions to a Roth IRA are not deductible, but are then allowed to grow tax-free.

Traditional IRA

Eligibility: You can set up and contribute to a traditional IRA if you have taxable compensation (i.e., income from work, such as wages, salaries, self-employment income, commissions, etc.) and are less than 70-and-a-half years old.

Contributions limits: In general, your contribution limit is the smaller of $5,000 or your taxable compensation for year.  This limit is a combined limit for all of your traditional and Roth IRAs.

Deduction: Not everyone who is eligible to contribute to a traditional IRA can take a full deduction on their contribution.  If you are not covered by a retirement plan at work (e.g., self-employed) and are single, head of household or a qualifying widow(er) or are married and your spouse is also not covered by a retirement plan, you can take a full deduction.  But if you or your spouse is covered by a work retirement plan, the amount of the deduction you can take will depend on your AGI.  For more information, see tables 1-2 and 1-3 in the IRS’s Publication 590.

Withdrawals: Withdrawals from traditional Roth IRAs count as income and will be taxed when you file your income tax for the year you make a withdrawal.  Any withdrawal made before you are 59-and-a-half will incur an additional 10% tax.  If you are over 59-and-a-half years old, you can make withdrawals from the account without incurring the additional tax, and once you are 70-and-a-half, you are actually required to make withdrawals.

Roth IRA

Eligibility: Anyone can set up a Roth IRA, but to make a contribution your modified AGI must be less than $120,000 if you are single and $176,000 if you are married and filing jointly or a qualifying widow(er).  An interesting article on the WSJ shows how to get around that limitation, however.

Contribution limits: As with the traditional IRA, your contribution limit to a Roth IRA is generally the smaller of $5,000 or your taxable compensation for year, and this is actually a combined limit for all of your traditional and Roth IRAs.  However, your contribution limit to a Roth IRA is also reduced if your AGI is at least $105,000 if you are single and $166,000 if you are married or a qualifying widow(er).

Withdrawals: Withdrawals from Roth IRAs are not included in your gross income when filing your income tax, and are thus income-tax-free.  But any withdrawal from your Roth IRA made before you reach the age of 59-and-a-half will incur the additional 10% tax.  Once you reach 59-and-a-half years of age, there are no taxes for withdrawing from your Roth IRA and you are never required to withdraw from it either.

Now that you know the basics on IRAs, here are two other important facts.  First, the deadline for making contributions to traditional and Roth IRAs is actually the day you file your taxes.  That is, before you start panicking that you do not have enough time to save for your maximum contribution, note that you have until April 2010 to make your 2009 IRA contribution.  And second, if you make a contribution and then change your mind within the same year you made it, you can withdraw the contribution (plus the interest or income earned on it) and it will be as if it never happened.  Of course, you cannot take a deduction on your contribution if you do that.  However, you also will not have to pay any penalties or fees, though you will have to report the interest or earnings from it as income when filing your income tax.

Roth If You Can’t Match

A few weeks ago, we wrote about checking to see if your employer offers matching contributions to your 401K and, if they do, making sure that you start contributing.  The economic downturn, however, has led many employers to cut benefits, and matching contributions have been frequently one of the first ones to go.  If you find yourself in this situation, stop contributing to your 401K account immediately.  Instead, open a Roth account and start saving towards retirement there.  Click here to learn the difference between these two accounts.

Like your 401K , your investment options for Roth range from CDs to bonds to stocks.  You are only limited by the investment firm you choose.  Companies, such as Fidelity, Vanguard, and T. Rowe Price, have fund options that do not charge sales fees or commission.  There might be, however, initial deposit requirements ($3,000 at Vanguard), minimum monthly contribution requirements ($200 per month at Fidelity) and annual fees if the account is below a certain threshold ($10 a year at T. Rowe Price for mutual fund accounts with balances of less than $5,000).

As for the 401K account, you have the option to roll it over to a traditional or Roth IRA when you terminate employment.  But for now, just let the money sit and grow.  While these retirement funds have been hit hard, the economy is rebounding and good news is all around.  Just this quarter, my account actually accrued earnings!  Soon enough yours should too.