Dear Liz: Recently I’ve paid off almost $20,000 in credit card debt and am determined not to go down that path again. Because I haven’t used these cards in a while, though, I’m starting to get notifications from the credit card companies that they’re closing my accounts because of inactivity. I know having long-standing accounts on your credit report is a good thing, but I don’t want to be tempted to use these cards just to keep the account open. Is it a bad thing if almost all of my credit card accounts get closed?
Answer: Your good histories with these cards should remain on your credit reports for years. But if you stop using credit entirely, eventually your credit reports won’t generate credit scores. That could cause you problems if you later want to borrow money (say, to buy a home) and could even affect your insurance premiums, since insurers use credit information as well.
It’s not too hard to keep accounts active without slipping into debt again. Simply set up a bill to be charged automatically to each account, then set up automatic payments with the credit card issuer so the full balance is taken out of your checking account each month.
Dear Liz: As a CPA financial advisor to individuals and small businesses, I devour your column. It’s almost always spot on. But the first sentence of your advice to the person whose 401(k) doesn’t offer a match — “start looking for a better job” — was not, and you missed an opportunity to educate your readers in how to compare job compensation.
I encourage my small-business and wage-earning clients to adopt a “total compensation” view to evaluate labor costs and to talk wages with their employees or employers. Employer A offering $100,000 might be better, worse or equal to Employer B offering $70,000 plus retirement plan match and, more importantly, employer-subsidized family health insurance. Besides the intangible factor of job satisfaction, one just doesn’t know which employer’s total financial compensation is “better” without crunching the numbers before and after tax. The two companies might be different only in philosophy of how compensation is paid, not better or worse.
Answer: Some jobs come with pensions or pay so good that the lack of a company 401(k) match is all but irrelevant. It’s safe to say those jobs are not in the majority. The median full-time wage at the end of last year was under $44,000, which means half of all workers earned less. Given stagnant incomes and rising costs, many workers have a tough time saving, so the extra help provided by a company match can make a world of difference in their ability to achieve a comfortable retirement.
Nine out of 10 employers that have a 401(k) offer a match, according to PlanSponsor.com, so plans that don’t are definitely outliers. The most common match is now 100%, or one dollar for each dollar contributed, up to 6% of the worker’s salary, according to the most recent Aon Hewitt study. Nineteen percent of the employers surveyed offered this match, up from 10% in 2011. The most common match used to be 50 cents for each dollar contributed up to 6% of salary.
Clearly, more employers are getting the message that good company matches are an excellent way to signal that they care about their employees’ futures.
Dear Liz: My son is 52 and has been unemployed for three years. He has been forced to withdraw money from his 401(k) and pay early withdrawal penalties on it to pay his mortgage and other bills. Is there such a thing as a hardship exception to avoid this tax bill?
Answer: There’s a way to avoid the 10% federal penalty, but not income tax, on early withdrawals from retirement accounts when someone is under 591/2 (the usual age when penalties end). The distributions must be made as part of a series of “substantially equal periodic payments” made using that person’s life expectancy. When these distributions are taken from a qualified retirement plan, such as a 401(k), the person making them must be “separated from service” — in other words, not employed by the company offering the plan.
Your son wouldn’t be able to withdraw big chunks of his savings, however. Someone his age who has a $100,000 balance in a retirement plan could take out about $3,000 per year without penalty. Revenue Ruling 2002-62, available on the IRS site, lists the methods people can use to determine these periodic payments. If he might benefit from this approach, it would be smart to have a tax pro review his calculations.
Dear Liz: Lately I have been reading a lot about how people aren’t saving enough for retirement. Every article I read talks about the need to put enough into employers’ 401(k) programs to get the maximum possible company match. What do you do when your employer doesn’t match your contribution?
Answer: You contribute anyway, and start looking for a better job.
The advice that people should contribute at least enough to get the maximum match is designed to ensure that workers don’t leave free money on the table. That’s essentially what a match is — a free, instant return on your contributions.
Maximizing the match doesn’t mean you’re contributing enough for a comfortable retirement, however. The match may be 50 cents for every dollar you contribute, but most companies won’t match more than 6% of your salary. Most people need to save more than that — sometimes much more, especially if they got a late start.
If your company’s 401(k) doesn’t offer a match, then you will need to save more to make up for the free money you aren’t getting. Because most plans offer a match, though, it may be worthwhile to look for an employer that offers this benefit as it can make retirement saving easier.
To figure out how much you need to save, use a retirement calculator such as the one at the AARP.org website.
Dear Liz: My husband and I are 56. We need to plan for retirement, but whenever the topic comes up, I find that either we have no idea or we disagree on what we will do during our retirement. Naturally, our activities during retirement will affect the funds we will need. We need help to figure out the things we agree on and where we might want to plan for different individual options. Do you have some resources to suggest?
Answer: You can start with a visualization exercise that some financial planners use to clarify their clients’ values.
Imagine your ideal day in retirement. Start with when you’ll wake up and where — what type of dwelling and in what area. In your mind, walk through your day hour by hour — where you’ll be, what you’ll be doing and with whom. Write it all down, even if you don’t think what you’re visualizing is realistic or even possible. The point is to identify, for yourself and your partner, what’s most important to you: what you want your life to be like and whom you want in it. If you visualize waking up in Paris, for example, it doesn’t mean you need to move there. You may be just as content with a trip to the City of Light or travel to less-expensive destinations.
You each should do the exercise separately and then compare what you’ve written. Don’t despair if you visualize yourself on the Champs-Elysees and he’s fishing off his back porch. As you correctly note, you can have different goals and desires for retirement. Complete harmony has never been a requirement of staying married, and that won’t change when you quit your jobs.
Let’s say you want to get deeply immersed as a volunteer for a local, at-risk school, and your husband wants to spend a year roaming the country in an RV. He could opt to pursue other interests during the school year, and you could take extended trips together during the breaks.
Once you’re clearer about what you want for your retirements, you can start working the numbers and figuring out compromises that work for both of you. Start with your expenses — what you’re spending annually now — and subtract any costs that will disappear or substantially diminish when you retire (such as commuting expenses and work clothes). Add in the amounts you’ll need to pursue your passions. (Will you buy the RV used or new? In retirement or before? Tip: Buying a lightly used vehicle before retirement will give you both a chance to get the hang of RVing and its costs so you can decide whether it’s really for you.)
Compare your expected expenses with your expected income, including Social Security, any pensions and withdrawals from your retirement accounts (which initially should be just 3% to 4% of the total balance, planners say). If there’s a gap, that’s what you’ll need to fill in the coming years with increased savings.
Still at an impasse? Hire a fee-only planner who has experience in “life planning,” or helping clients figure out their life goals. You can get a referral from the Kinder Institute of Life Planning at http://www.kinderinstitute.com/dir/.
Dear Liz: I have about $16,000 in student loans at 6.8% interest. At the current monthly payment it would take me about 7.5 years to pay them off. I contribute 10% of my income to my company’s Roth 401(k) plan (my employer matches the first 6% contributed). I also contribute 3% to the stock purchasing plan. I am thinking of cutting back my 401(k) contribution to 6% and not contributing to the stock purchasing plan. Applying the extra money to my loans would reduce the payback period to about 2.5 years. After that, I would increase the contribution amount and diversify with a Roth IRA as well and maybe even begin the stock purchase program again. What do you think?
Answer: Not contributing to retirement accounts is usually an expensive mistake. The younger you are, the more expensive it can be.
Every $1,000 not contributed to a retirement plan in your 30s means about $10,000 less in retirement income. That assumes an average annual growth rate of 8%, which is the historical average for a stock-heavy portfolio.
In your 20s, the cost of not contributing that $1,000 is $20,000 of lost future retirement income. The extra decade of not getting those compounded returns makes a big difference.
People have the erroneous idea that they can put off retirement savings and somehow catch up later. Catching up, though, becomes increasingly difficult the longer you wait. A better approach is to save as much as possible starting in your 20s when the money has the longest time to grow. Then you’ll be in a better position to withstand job losses or other interruptions of your ability to save. If those setbacks don’t happen, you’d have the option of retiring early.
Granted, your plan would require reducing retirement contributions for just a few years. But the federal student loans you have are fixed-rate, tax-deductible debt that you don’t need to be in a hurry to pay off. In the long run, you’d be much better off boosting your retirement contributions.
If you’re determined to pay down your loans, however, use the money you’ve been contributing to the stock purchase plan. Continue making at least a 10% contribution to your retirement plan and increase that as soon as you can.
Dear Liz: I would like to start a Roth account for each of my kids. (They’re in their 30s.) Is it better to start an account in my name with them as beneficiaries or to start the accounts in their names?
Answer: Roth IRAs can be a wonderful way to save, but they’re not custodial accounts. You won’t be able to control the accounts or prevent your adult children from spending any money you deposit.
If you still want to help, though, let your kids know you’ll contribute to any Roths they set up. They can open a Roth if they have earned income at least equal to the annual contribution and their incomes are below the Roth limits. The ability to contribute to a Roth phases out between $178,000 to $188,000 for married couples in 2013 and from $112,000 to $127,000 for singles.
Ideally, you’ll contribute to your own Roth first. The limit on contributions is $5,500 this year.
Dear Liz: My 401(k) plan has grown exceptionally well this year. I think we all know that it can’t last. I just recently heard about self-directed IRAs. I was intrigued at the possibility of opening one by rolling over a portion of my 401(k) money directly. The problem is, my company’s 401(k) provider will not allow the direct rollover of funds. Is there an alternative means of withdrawing 401(k) funds without penalty and still get them into a self-directed IRA?
Answer: You can quit your job. Otherwise, withdrawals while you’re still employed with your company will trigger taxes and probably penalties.
Your premise for wanting to open a self-directed IRA is a bit misguided, in any case. Your 401(k) balance may occasionally drop because of fluctuations in your stock and bond markets, but over the long term you should see growth.
You may have been sold on the idea that self-directed IRAs would somehow be less risky. Some companies promote self-directed IRAs as a way to invest in real estate, precious metals or other investments not commonly available in 401(k) plans. The fees these companies charge as custodians for such accounts are usually much higher than what they could charge as traditional IRA custodians, so they have a pretty powerful incentive for talking you into transferring your money to them.
The problem is that you could wind up less diversified, and therefore in a riskier position, if you dump a lot of your retirement money into any alternative investment. It’s one thing for a wealthy investor to have a self-directed IRA that invests in mortgages or gold, assuming that he or she has plenty of money in more traditional investments. It’s quite another if all you have is your 401(k) and you’re putting much more than 10% into a single investment.
Also, there’s a lot less regulation and scrutiny with self-directed IRAs than with 401(k)s, which increases the possibility of fraud. (Southern California investors may remember First Pension Corp. of Irvine, a self-directed IRA administrator that turned out to be a Ponzi scheme.) So you’d need to pick your custodian, and your investments, carefully. You also would need to understand the IRS rules for such accounts, because certain investments — such as buying real estate or other property for your own use — aren’t allowed.
If you’re determined to diversify your investments in ways your current 401(k) doesn’t allow, you can open a regular IRA at any brokerage and select from a wider variety of investment options. Or you can look for a self-directed IRA option with low minimum investment requirements to start.