Tag Archives: retirement accounts

The Flip Side of Retirement Planning and Living Longer: Paying for College

  By petillo | October 8, 2010 - 5:46 am | college, financial planning, personal finance, Repercussions: A Retirement Review, Retirement Planning Target 2025
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So they have been telling you are going to live longer. They, who group come to the discussion as experts from a wide swath of scientific fields have determined that we are going to live well past the age that our parents will attain and because of this, we are in some serious financial trouble. Retirement accounts are not robust enough to sustain such a prediction which has caused one outlandish reaction: work longer. And another result of this new longer life, we feel as though our retirement accounts can be built (or in many instances, rebuilt) should we need the funds.

Most of us have heard that starting early leads to bigger account balances thirty or forty years later. And some of us did heed that call to begin the process at an early age. We were prudent and optimistic. Yet at some point, we also became realists. If we are poised to work until we are well into out seventies, does forty years old become the new twenty? If we have this enormous stretch of time in front of us and we know that accounts do better over a longer period, wouldn’t the rational also suggest that if we used those accounts to fund college, those accounts would recover?

The answer to both questions would be yes. There are a couple of things at play here when the conversation turns to how to pay for college for your kids. One is the continued belief that this financial outlay will be worth it no matter the cost (if you attended college, this becomes a mote point and if you didn’t the concept that the education will improve your child’s life, helping them rise above the financial status you as parents have). And both arguments have merit.

But which is better: saving for college before they attend, when your resources are limited or helping them pay for it after-the-fact when your income might be better suited to help pay for the outstanding loans? There will always be those who believe that the before-the-fact accounts will give parents peace of mind that their children will be able to attend college. 529 Plans, offered at the state level, do have tax incentives for those that use them.

But for the parents who are just beginning with a household income of less that $80,000, channeling that money into your retirement is a far better choice. I argue this for two reasons: one, the cost of getting a child to college age has increased faster than the cost of tuition. Neither are getting less expensive and it is far easier to embrace what you know rather than plan for the unknown.

And secondly, money will always be available to borrow for college and usually at a relatively competitive rate. While the student remains as student, no payments are made on the loan except in some instances, interest payments might be required. This is budget-able and do-able cost for the average family. In addition, you may actually be in a better financial situation to help with those post-college expenses as an older parent than you were when they were toddlers.

There is no denying that college has merits. There is also no denying that the costs are going to continue to rise. I just believe that as long as the money can be borrowed and the length of time to pay it back is as long as it currently is, the cost of this after-the-fact experience is worth it if, and this is a big if, you financed your retirement during those formative years – when you were young.

Sacrificing your retirement account’s funding in those early years is not offset by the rewards of higher education. Fund yourself first, then your kid’s college. No child wants a financial insolvent parent to care for because you put them through college when you could have been insuring a healthy retirement instead.

Defining Emergency

  By petillo | May 18, 2010 - 6:59 am | Repercussions: A Retirement Review
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A great many of us have difficulty defining what an emergency is. We have some grasp of what the situation is once we are in it, but when it comes to financial emergencies, every bump in the road can seem disastrous.

Most emergencies happen rather quickly. The sudden loss of a job qualifies as just such an event. Although, in many instances, the so-called “writing on the wall” was visible long before you actually lost your employment. The reactions to those losses however need to be carefully considered and certainly not rushed.

Most financial disasters unfold very slowly. Which is why we build emergency accounts with financial products that will give our money a chance to grow somewhat while it waits for a use we hope we never need.

So how liquid does an emergency account need to be? For most of us the answer is not-so-simple: easy enough to get to but not so easy to get to that you will be tempted by the easy access. We know that retirement accounts do not serve this purpose. We know that credit cards and home equity lines also fail at providing emergency coverage.

Which is why so many people use certificates of deposit instruments to keep their emergency money safe. Used correctly (by laddering the purchase, buying CDs at different maturity dates) these financial tools can be a great place to park money in the short-term. But using them as an emergency account might not be one of them.

On the surface, the access seems easy and the penalties for before maturities withdrawals might seem like something you can live with. But the banks will come out the winner should you need the money before the CD matures.

In the case of CDs with less than a year to mature, the penalty for early withdrawal is three months interest. For a one-year CD, the penalty is six months interest. For a five year CD, the penalty is 20-25% of the interest. That may not seem so bad except that penalty may be on interest you have yet to earn. Which means, the bank may actually be taking some of the principal.

Using CDs can be a great way to make a little bit of interest on your reserve accounts, but using them for emergencies may not work out as planned. And certainly would not be considered a profitable place to park your money for emergencies. Keep your money liquid and without fear of penalties should you need it. You may not make anything worth noting in the process. But at least you will not be penalized if you do need it.

To get the most current CD rates.

Taxes: Which Fund is Tax Friendly?

  By petillo | February 17, 2010 - 12:53 am | 401k, Mutual Fund Investing, Profitable Investments
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I just recently finished my portion of the household tax return for 2009. I was not that unpleasant a task as I broke even for the year. Some stocks made money while others lost enough to offset those gains. In other words, the best possible tax scenario took place: no gains, no tax consequence. But that was my mad money account, a little side game I play in the stock market based on advice given to everyone who read Benjamin Graham’s work: The Intelligent Investor.

Graham invented the term “mad money account” suggesting that after your financial house was in order, after your retirement was fully funded, it was quite alright to play the stock market, if only to teach you a lesson in how heartless investing can be. He believed that some folks had it while others would never possess the skill needed to make a sufficient amount of profits to be considered a successful investor.

Oddly, most of us disregard this advice believing that we can become investors, and good ones at that, with the information we have at hand. And some of us do. But the vast majority do not. Unless of course we use mutual funds.

While mutual funds have always been a somewhat difficult concept to understand, it is what we have to work with. And because the vast majority of us who come into contact with these funds do so inside a 401(k), an account where the taxes that might be paid by an investor outside are deferred to some point in the future, do taxes matter?

Yes and no. Yes because mutual funds can deliver tax consequences that eat away at your returns and no because if you pick the right fund, those tax events will have less of an impact on your return which means more retirement dollars.

How do mutual funds create tax events? Unfortunately, the same way you create them as an individual investor: buy selling profitable holdings. Mutual fund managers look for great stocks and when they find one, they hold on to it. So utterly confused tip one when looking for a good mutual fund is to find a manager who trades infrequently.

This is expressed as portfolio turnover. If a fund manager buys and sells everything she or he owns in a given year, the turnover is 100%. The lower the turnover, the lower the trading costs and the lower the chances are you will have to pay taxes. The higher the turnover the more likely there will be some taxes to be paid and a greater chance of lower overall returns.

But sometimes, as was experienced at the end of 2008 and into 2009, mutual fund investors, just like everyone else panicked and sold their shares in the fund as their portfolios fell in value. When this happened, the fund manager had to give them cash and the only way they were going to get the cash was to sell something. If it was a profitable holding, it created a tax event.

But who paid the taxes? Unfortunately, it was the shareholders who didn’t sell. And sometimes the new shareholders who unwittingly bought into the fund just as the taxes were distributed. In a mutual fund, every thing is, well, mutual: the gains, the losses and the taxes.

An older gentleman once suggested that taxes were one way to know you made money. But how do you avoid them? Second utterly confused tip: only buy after a scheduled distribution. They generally take place at the end of a quarter or the end of the year. Buy in after that, and the taxes you pay are on the shares you own.

The last utterly confused tip for mutual funds is finding a long-term manager. This is not as easy as it sounds especially if you are locked in a plan that has only a few funds or funds from the same family. Look for a fund with a good long-term consistent performance instead. This is one indication of stability in trading and as a result, less taxes to subtract from your return.

You may pay taxes on your gains when you retire and when you begin to take distributions, but the fund pays taxes on its activities all along and deducts them from your returns.