Tag Archives: 401k

The Pension: My Golden Handcuffs

Working in government for New York State, I am fortunate to have very good benefits. One of the benefits is having a pension plan (defined benefit plan). All of my co-workers talk about their retirement date in terms of how old they are and how many years they have in the “system.” It has nothing to do with how much they’ve saved and many save very little if anything for retirement. They are solely relying on the pension program. Some don’t retire even when they have enough time in the “system” and are old enough, because they live above their means and cannot live on anything less than their current income.

Many who don’t have pensions are understandably envious of those who do have it. I am very fortunate to have one and I don’t want to seem like I’m complaining about this wonderful benefit, but there are a few downsides of the pension for me.

With a 401k plan, the money is often portable. You save money in it. Your employer makes matching contributions. It might take a year or a few years to vest, but the money your employer contributes is yours to keep. The gold plated pension of older employees has been watered down for younger employees. For new employees, the pension plan doesn’t vest until you’ve worked for the employer for 10 years. So if you leave before then, you get no pension. They’ve also increased the retirement age from 55 years old to 62 years old. I don’t like someone else deciding when I can or cannot retire. I’d rather make that determination based on how much I’ve saved and how much I will need, not some arbitrary thing like how many years I’ve got in the system.

Another issue with pensions is that if the company goes bankrupt, it’s very likely retirees will lose the pension or get a amount that is a lot less than they were expecting. I work in government which has a slightly lower chance of bankruptcy, though you can never discount it. Some states’ pensions are in better shape than others. If you work for the State of Illinois, well then, I think you might want to worry a little more. Currently, the state constitution in New York explicitly protects pension payments. However, that doesn’t mean there will never be an amendment to the state constitution.

Having that pension also makes it hard to pull the trigger on other job opportunities currently. I can’t say that I’ve really been wowed by another job which tempted me to leave or that I’m actively looking. However, when I’ve checked out prospective jobs elsewhere, a part of me does think, “if I leave, I won’t get that pension!”

As someone aspiring to become financially independent and possibly retire early at age 45 , the pension makes the decision to leave a lot harder. So what will my pension pay? If I stay until I am 55 years old, after having worked 30 years, I will get a pension which pays a yearly benefit of about 60% of your highest three-year average salary. Let’s say my highest three-year average salary is $100,000, I will get a yearly benefit of about $60,000. Yea, I know I know…I am very lucky to have this pension. However, if I decide to FIRE at age 45 with 20 years of service and let’s just assume the same three-year average salary of $100,000, the pension would only pay $29,200 based on the online calculator. Note: I would have to wait until age 55 to collect the pension. If I decided to leave at age 50 with 25 years of service, based on the same salary, I would collect $36,500. If I waited until age 54 with 29 years of service, I would get $42,300. Obviously, if I stayed until 54, I would just go one more year to get the full amount! Yes, having a pension is a wonderful benefit, but it can also be a handcuff, albeit a golden one.

Is there a golden handcuff holding you back from leaving your job? Do you have a pension and would you take the penalty to retire early?

I’m Frugal…Now What?

Piggy bank2

In my post Live Like a College Student, I encouraged new grads to continue being frugal and to save money. But what if you’re already frugal? I know a few friends and relatives in their 20s who aren’t living the high life and have a healthy savings rate, but unfortunately, the money is sitting idly in a bank account. So what should they be doing with their money instead?

Invest it!

“But I’m scared of the stock market,” you say

Rather than leaving a large amount of your savings in a bank account, make your money work for you. Many people, especially millenials, fear the stock market. While it is understandable to be apprehensive being that you observed the 2008 stock market crash and subsequent recession wreck havoc on many people’s finances. The media has also done a great job in scaring people. However, you have to invest your money if you want to build wealth. Hiding the bulk of your savings in your mattress or in a savings account won’t do that. In fact, the value of your money will be eroded by inflation. No one can predict what the stock market will do, but it’s very likely that another stock market crash will occur. But that’s okay because the stock market has historically given investors about an 8% return. Remember, you’re young and you’re a long-term investor. The next time there is a stock market crash, just think of it as stocks going on sale and a buying opportunity.

But I don’t know how to invest?,” you ask.

Index Funds

Other than being scared of investing, a lot of people are also intimidated because they don’t know the first thing about investing. Don’t worry if you don’t know much about investing or have any inclination to learn. You can set up a “lazy portfolio” and it’ll probably perform better than your friends who “think” they can beat the stock market. Or if you want to be even more hands-off, just invest in an “all-in-one” fund.

Some, on the other hand, think they know more about investing than they really do and “invest” in individual stocks. For most people, they’re better off sticking with index funds. Like many of my peers when I was in my 20s, I thought I could beat the market by predicting which stocks would soar. Well my track record is pretty poor, and I would have done a lot better just investing in an index fund.

Automate your savings

Automating your savings makes saving money easy. By having money automatically sent from your paycheck to your 401k/IRA account/etc, you take the stress out of saving. Even better, every time you receive a raise, increase the amount you save. I have received steady increases in pay the last few years, but my paycheck has stayed about the same. This prevents lifestyle inflation as you’ll never miss the money since it is out of sight, out of mind.

As for your 401k, don’t settle for saving up to the match. Save much more than that if you have decent options in your 401k (if not, invest in an IRA account). At my first job, my employer matched up to 5%, and I thought I was a rockstar when I increased my contribution to 7%. That’s just not going to cut it. But of course, at a minimum, invest up to what your company matches. Don’t make the mistake of many Boeing employees who have collectively turned down $98 million in matching funds by not contributing up to the match.

Real Estate: Should I buy or rent?

For most people in their 20s, just starting in their careers, it’s probably better to rent rather than buy a place. You want the flexibility just in case your career takes you someplace else. You don’t want to be forced to sell your home as there are transactional costs and you might get caught in a down market. Plus, you’re young, who wants to be stuck maintaining the yard and taking care of other home-related projects? However, there are some instances where I do think it would make sense to buy a house at that stage of your life.

I have a friend who purchased a duplex a few years after he graduated from college. He rented out one unit and also rented a room to a friend in his unit. The rental income that he received paid for his mortgage. He was living rent-free! Now, years later, the property has also appreciated so it’s been a great investment for him. So, I think it makes sense to purchase a house in your 20s if you’re purchasing the property as an investment and it will cash flow. It definitely depends on where you live. It makes sense to buy in some areas in the country, whereas it makes more sense to continue renting in other parts. Check out the Rent vs Buy calculator to help you make your decision.

Increase your income

Invest in yourself and acquire marketable skills to increase your salary. While in some circumstances you may need to go to graduate school, you don’t necessarily have to quit your job to acquire new skills, as it’s possible to learn new skills online. Check out Udemy or Treehouse. Another way to increase your income is to have a “side hustle” or part-time job. Check out this site for a list of 50 side hustle ideas.

What other advice would you give to someone just starting out on their financial journey? What advice would you give your 22 year old self about finances?

Tax Shelters for You and Me

credit: freedigitalphotos.net by Stuart Miles

credit: freedigitalphotos.net by Stuart Miles

Last year, when the media reported that General Electric paid no corporate income taxes people were furious. During the last presidential election, there were accusations that Mitt Romney had paid no income tax for a decade. Whenever we read about tax shelters, we think of the wealthy one percenters stashing their cash in the Cayman Islands or using some complicated loophole to avoid paying taxes to Uncle Sam. But how about tax shelters for us regular Joes. Here are a few ways you can reduce the amount of taxes you have to pay.

Tax Deferred Retirement Plans (401k, 403b,457, etc)
Many people have access to a tax deferred retirement plan such as a 401K through their employer. Employer provided matching funds are not the only benefit of these plans though, there is also a tax benefit. If you participate in your traditional 401k, you can save up to $17,500 per year (2013 and 2014) in tax-deferred contributions ($23,000 if you are over 50 years old). Every dollar you contribute reduces your taxable wages, thereby lowering your taxes. Some employers offer a Roth 401k in which case, your taxes are not lowered, however, all the money in the account grows tax-free and you will not need to pay taxes on it when you withdraw from the account. With the Traditional 401k account, you lower your taxes presently, but may have to pay income tax when you withdraw from the account.

Individual Retirement Plans
If you do not have access to a 401k plan, or even if you do but prefer to invest on your own, you can open an IRA. Much like the 401K plans, you can reduce your taxable income by contributing money to a traditional IRA. If you prefer, you can open a Roth IRA account which will not lower your taxes, but will allow the money you invest to grow tax-free. The maximum contribution is $5,500 for 2013 and 2014. To learn more about IRAs and the income limits that apply, click here.

Note: If you don’t already have enough incentive to save for retirement, there is a tax credit up to $2,000 just for saving for retirement. Income limits apply. Check out this link on the IRS website for more details and to see if you qualify.

Flex spending account

Health Care
The Health Care Spending Account is an employee benefit that some employers provide which helps pay for health-related expenses with tax-free dollars. This includes medical, hospital, laboratory, prescription drug, dental, vision, and hearing expenses that are not reimbursed by your insurance or other benefit plans. The maximum contribution for 2014 is $2,500. The open enrollment deadline is right around this time in November so check if you have this benefit and take advantage of it. A lot of people don’t take advantage of this plan probably because they don’t know about it, are too lazy to submit receipts or they are scared about the “use it or lose it” aspect of it. If you have a good estimate of the medical expenses you will be spending during the upcoming year, the flex spending plan is a great deal. If by the end of the year you still have money to spend, you can buy various medical supplies that qualify such as contact solution and bandages. Drugstore.com has an entire section under the FSA tab which sells items that qualify.

Note: Health Savings Plans (HSA) which are different from the health care flex spending account is also a great way to reduce your taxes. It is not “use it or lose it” so you can leave money in your account. I’m not that familiar with this type of plan so I won’t get into it. However, you can read this Forbes article if you are interested in learning more about it.

Dependent care

For those of you with kids, the dependent care account will take some of the bite out of paying for daycare which is pretty pricy. Other expenses that are eligible for this account include babysitters (allowing you to work), nannies, summer camp, and possibly for elder care as well. You can contribute up to $5,000 in your dependent care flex spending account. For more information about eligibility and qualified expenses, click on this link.

Tax free commuter benefits
If your employer offers this benefit, it allows you to save a good amount of money on your commute to work. Commuters can use pre-tax dollars to pay for the subway, bus, train, ferry, car, or vanpool. To see how much money you can save, use this calculator.

If you are interested in reading about how real families drastically reduced their tax bill check out the following posts:
How a Family of Four with a $100,000 yearly Income Pay Only $6400 in Federal Income Tax by Brad from Richmond Savers
Six Figure Income Pay No Tax by Justin from Root of Good.

I am not a tax expert so please consult a tax professional or do your own research before making any decisions.

Do you take advantage of any of the above to reduce your taxable income?