A recent study shows a change in the way that companies are approaching 401(k) plans. The typical 401(k) plan is set up to where employers will provide a $0.50 on the dollar or a dollar for dollar match to any contributions by the employee. Well, things have changed since the start of the credit crisis and recession. Similar to most recessions, employers will suspend the employer matching contributions program until the economy starts to rebound. This time 401(k) consultants say there is a different response.

Consultants are reporting that their clients are either stopping the matching program altogether or making the match available to employees only on the basis of profitability of the company. In other words, if the company makes money, then the employee gets the match. This credit crisis has really made employers rethink the matching contributions program.

Does it make sense to keep investing money into a 401(k) plan? If your 401(k) plan doesn’t have a match, I would argue that it makes no sense to continue investing into it. The employer match (or free money as I like to call it) is the biggest benefit of a 401(k) plan. Beyond that, there are more cons than pros to a 401(k) plan.

1) Lack of investment choice – Most 401(k) plans do not have enough choices for investment. I have looked at 401(k) plans with as little as 5 investment funds available for investment. That is clearly not enough diversity. Even if the plans have plenty of funds, they don’t have enough different types of funds. They might have 10 stock funds and 4 bond funds. As we saw last year, bonds and stocks can both lose money at the same time.

2) Lack of secure investments – Most 401(k) plans at least have a money market; however, some do not. Last year I looked at plenty of 401(k) plans that literally had no safe place for the participant to put their money.

3) High expenses – When it comes to expenses, you don’t have a choice. You are stuck with those high built-in 401(k) plan expenses. With 401(k) plans, there are a lot of people who are to be paid something. That is all built into the hidden expense ratio. There has been a lot of talk coming out of Congress to force better disclosure of these expenses.

What is the alternative? If possible, max out an IRA or a Roth IRA. Yes, the only other advantage to a 401(k) plan is the tax deduction and you will forgo the majority of the tax benefit if you are maxing out the 401(k) plan. However, with an IRA you can still get at least $5,000 (and depending on your age, up to $6,000) in tax deductions. Those limits will increase down the road as well. As a rule of thumb, I don’t recommend basing your investment decisions on tax savings. What if you were investing more than $5,000 or $6,000? You would then consider opening up an investment account and saving into that account with the additional money. Having money in a taxable investment account can be a very prudent way to save.

You have two other advantages with an IRA as your retirement vehicle of choice. First, you have at your disposal a selection of all of the categories of investments available on the market. You can also control expenses more effectively with an outside plan based on the investments that you choose.

Most importantly, you can have your IRA managed for risk and growth. That is a big deal. The best you can hope for with a 401(k) plan is a buy and hold strategy which has proven to be fatal for your account values.

Tags: 401(k), 401(k) Plan, Bob Brooks, bonds, Congress, credit crisis, Deceptive Money, expenses, investment choices, IRA, matching contributions program, money market, Prudent Money, Roth IRA, stocks, tax deductions

New Stock Market Alert : Summer Time Blues

New Debt Tip : Prudent Mortgage Refinancing Isn’t About Getting a Lower Payment

I had the opportunity to go on vacation last week. My family and I went to Red River, New Mexico. I guess this was good for me. There was no internet where we were staying. The satellite went in and out not giving me much access to news. My iPhone would work only when we were in town. So, for the first time in as long as I can remember, I was literally out of touch with the crazy world of markets.

It gave me some time to think through what was happening in the economy and stock markets without the constant interruption of market news. There are so many various risks that you could consider right now. In thinking through it, there is one risk that should be followed by an explanation point. In fact, it is one risk that I think will ultimately be a real problem for the stock market.

Allow me to take you through my thought process. We invest money in order to make it grow so that we can use it for specific financial goals down the road. Unfortunately, things aren’t always rosy when it comes to the wonderful world of investing. There are periods of time when you can lose a lot of money. So, you have two choices. First, you can just buy and hold and HOPE that everything works out well in the end. I adamantly disagree with the financial services industry that you just hold tight and take the losses during those times. Second, you can be more proactive and reduce risk (reducing how much money is invested in any type of stocks or stock funds – for further explanation see below) and reduce the potential for losing money.

Today, it is tough to consider reducing risk in the investments. If you listen to politicians and Wall Street, the worst is behind us. Thus, it would be crazy to reduce your risk now. Then you start thinking of all of the craziness that is occurring. I think you would agree that it is risky out there but to what extent?

This is what every 401(k) participant and anyone invested in stock needs to know about risk. For me, there are many known and unknown situations today that create risk for investors. However, there is one that is easy to explain and one that I feel will ultimately spell a great deal of trouble for those who are not proactive. It comes down to what I would now refer to as the unemployment crisis.

Think through this cycle with me. For the stock market to be positive, we need a positive economic outlook. For a positive economy, we need consumers to spend money. For consumers to spend money, there needs to be plenty of jobs. Unfortunately, the unemployment situation gets bleaker as the months go by.

Before I write about it, let me make sure that I debunk a few counter-arguments. First, Wall Street will tell you that you are looking at the past when looking at the unemployment report and that things could already be getting better. Unfortunately, we look at unemployment numbers on a weekly basis and those are real time. Those look just as bad. Second, Wall Street will tell you that things always look bad before they get better. When there are no real solutions, unemployment can get much worse.

The latest unemployment report showed 467,000 jobs were lost. That was after the Government “estimated” 185,000 jobs were created (for an explanation of how these estimates work, read this report). If you didn’t count that “estimate”, we would look at a loss of 652,000 jobs for just last month. Since the beginning of the year, the Government has “estimated” over 500,000 jobs that were created out of thin air. Out of those 523,000 “estimated” jobs that were created, 56% of those jobs were “estimated” to be created in the…Leisure and Hospitality Sector. Of course, you could see where the Government would assume that sector is hot. After all, think of all of the money that Americans are spending in the Leisure and Hospitality Sector during the greatest recession since the Great Depression (please note the sarcasm).

The “stated” unemployment rate of 9.5% is the highest in 26 years. The Department of Labor has another employment rate that they follow, which adds back into the total, the workers who fall out of the system. That rate is 16.5%. Shadow Stats, which is a company that takes economic data and calculates the real numbers, shows an unemployment rate of close to 21%.

President Obama reassures everyone that this problem is getting fixed. He claims that many of these “infrastructure” projects are about to be started. In other words, he is about to create a handful of jobs to work on infrastructure projects. This is far from a fix for unemployment.

So this remains a major risk for the stock market and why I will continue to suggest that investors consider the risk that they are taking. Yes, the market could start to look better and could start making money for a period of time. However, any gains are going to be tough to sustain with this unemployment crisis hanging over our heads.

Note: You manage for risk two ways. First, you reduce your exposure to stocks and stock based funds. This is a very general strategy for reducing risk. Second, you can also have someone manage your money for risk.

Tags: 401(k), Bob Brooks, Deceptive Money, Department of Labor, economic data, economy, financial goals, financial services industry, Givernment, internew, Investing, jobs, news, politicians, President Obama, Prudent Money, risks, Shadow stats, stock funds, stock markets, stocks, unemployment crisis, unemployment report, vacation, Wall Street

On my program yesterday, I interviewed Pam Villarreal, policy analyst with the National Center of Policy Analysis. They have completed a project on the long-term effects of borrowing against your 401(k) plan. The results are disturbing.

They developed a 401(k) borrowing calculator that shows the long-term impact of borrowing from your 401(k) plan. Let me give you a good example:

$100,000 account balance
$10,000 borrowed
24 months pay-back
8% return on investments
Retire in 30 years

What was the difference in retirement savings? By borrowing $10,000 the retirement plan was short $229,445. There are many bad assumptions that are being made when borrowing from your 401(k) plan.

For a few good resources, check out their white paper on 401(k) borrowing. Also go check out the 401(k) borrowing calculator.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.

Tags: 401(k) Plan, Bob Brooks, Deceptive Money, National Center of Policy Analysis, Pam Villarreal, policy analyst, Prudent Money, return on investments

A listener posed a question yesterday regarding the Bennigan’s Restaurant closing and whether or not employees lost money in their 401(k) plans because of it.

After doing some research on the story, I discovered a few sound bites from some of the employees mistakenly stating that their 401(k) plans had been tapped for money. The reality is that with extreme exceptions, your 401(k) plans are very well protected in the event that your company files bankruptcy.

If an employer goes out of the business, the 401(k) plan is terminated. When a plan is terminated, affected participants are 100% vested (they own their employer match) in all employer money in their account, regardless of the plan’s vesting schedule. Participants are always fully vested in their own contributions. Participants always own their own investment accounts. This means that the money in the plan is now available to be distributed to the plan participants. Under the law, the employer, even in bankruptcy, can’t touch the money in the plan. The 401(k) plan money can’t be used for any other purpose except to pay benefits and expenses related to the plan.

The 401(k) assets are also protected by law from creditors.

Are there times when money is taken out of a 401(k) plan illegally? Yes, there have been instances in the past where fraud and illegal activity have occurred. However, it is much tougher today to get away with that type of crime.

In extreme cases, the Department of Labor steps in where there is abuse of the retirement funds, but that rarely happens.

What about pension plans? Well those are protected as well but by different means. Pension plan assets are protected up to certain limits by the Pension Benefit Guaranty Corporation. In this case, certain pension plan benefits could result in a loss due to a company going bankrupt. However, for the most part, everything should be covered.

Now there are stories such as Enron where employees lost everything in their 401(k) plans due to a company going bankrupt. That had nothing to do with a company taking the money out. Those losses were a result of an employee being heavily invested in their company stock. As a result of the company going into bankruptcy, the stock plummeted and was virtually worthless. Thus the employee lost their future.

As a rule of thumb, you never want to have more than 10 to 15% of your company stock inside your 401(k) plan. It is just too much risk.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.

Tags: 401(k) plans, bankrupt, Bennigan's Restaurant, Bob Brooks, Deceptive Money, Department of Labor, Pension Benefit guaranty Corporation, pension plans, Prudent Money, retirement, risk, stock

Since the development of the first 401(k) plan back in 1979, these retirement plans have been the first choice for investors. However, are they the best choice for your retirement money? Well, let’s take a look at the advantages of a 401(k) plan.

I can really only think of three. First, you do receive an up-front tax break on your annual deposits. I think that this is one of the main reasons most investors invest into the 401(k) plan and it is the tax break. However, is a tax break a good enough reason?

Second, and the only reason to invest into a 401(k) plan, is the employer match. It never makes sense to pass on free money. If an employer is giving away money, it makes sense take advantage of it.

Third, and maybe a stretch, it is a convenient way to invest money. There is a great convenience factor of the money never making it into your checking account and going directly into your bank.

So, what are the downsides?

First, the high expenses associated with investing in a 401(k) plan. Expenses inside of these plans are higher than most people think. Unfortunately, they are not fully disclosed and hidden.

Second, and the biggest drawback with 401(k) plans, is options. Most 401(k) plans don’t have enough of the types of investments that really help you an investor to properly diversify.

So, what is the verdict? In most cases, I have always believed that you take advantage of the match that an employer is will to give for investing into the 401(k) plan. That is a key advantage. Beyond the match, I don’t see a good enough reason for investing into a 401(k) plan. Once again, this is in most cases.

Most investors would still argue that the tax advantages make it worth it. I would argue that the lack of options in most 401(k) plans is a much bigger disadvantage.

So, what would be the alternative?

Consider investing the maximum amount possible into a Roth IRA. A Roth IRA will not give you a tax advantage up-front. However, it potentially gives you an enormous tax advantage when you withdraw the money. All of the money that you earn is never taxed during the growth stage and never taxed when you take it out. This is a tax-free distribution. In my opinion and in most cases, that will be a much greater tax advantage than getting a small up-front tax deduction.

Plus, you have the flexibility and all of the options that are afforded to you in a regular IRA brokerage account. You would no longer be restricted with limited options.

What if you don’t meet the requirements to invest into a Roth IRA? Well if you are a couple and your adjusted gross income exceeds 160,000, you cannot make a contribution. Instead, you make an after-tax contribution into an IRA. Then in 2010, new regulations take effect that will remove those restrictions on the Roth. You then transfer the money from the IRA into the Roth.

The only downside to this strategy is that you might owe taxes on some of the money that you convert to the Roth. However, the Government is giving you more than 1 year to pay the taxes back.

This is an example of how to get the best of all worlds while investing for retirement.

This is one way to invest for retirement. The key before implementing any strategy is determining if it is right for you.

Tags: 401(k), Bob Brooks, Deceptive Money, high expenses, investors, Prudent Money, retirement, Roth IRA, tax break

Investors are looking to a new source of cash and it isn’t the credit card. 401(k) borrowing is on the rise as consumers struggle to keep their finances together and their credit card payments current.

The bottom line is that borrowing from your 401(k) plan is a bad idea. It should only be considered as a last resort. First, let’s take a look at how these loans work. Most plans allow for participants to borrow up to 50% or $50,000, whichever is the highest. Then the loan is typically paid back over a period of 5 years. The benefit that most consumers are drawn to is that you pay yourself back with interest.

Why pay someone else interest when you can pay yourself?

Well, here are the drawbacks for borrowing from your 401(k) plan.

1) You pay taxes twice on the interest that you pay back on the loan

What most people don’t realize about paying interest back to yourself is that when you pay the loan back, you are using money that has already being taxed. A 401(k) plan has pre-tax money in it. Withdrawas from a 401(k) plan are taxed. Along with those taxable dollars is the loan interest that you paid taxes on already. Thus, you will pay taxes on that interest a second time.

2) You borrow once, you might borrow twice

If the 401(k) plan worked out to be a good thing the first time you borrowed from it, well it might become a convenient place to borrow a second time. Your 401(k) should remain sacred and untouched, reserved for your long-term security and not viewed as an ATM machine.

3) If you are laid off, that loan has to be immediately paid back

If you are laid off, the loan comes due. If the loan comes due and you are under the age of 59½, you then pay a 10% penalty in addition to ordinary taxes on the entire amount. That can be very expensive.

I can only think of a few scenarios when borrowing from a 401(k) would be a good idea:

- You are already paying excessive interest rates on current debt outside of the 401(k). A loan from the 401(k) could be a way to drop your interest rate from 30% down to 6 to 7%.
- Prevents you from defaulting on another loan. Remember, you always want to stay current at all costs.
- Borrowing from your 401(k) plan could result in an increased credit score. Moving debt off the books could increase your credit score. By increasing your credit score, you create the opportunity to lower interest rates and refinance that debt and then pay off your 401(k) plan loan.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.

Tags: 401(k), Bob Brooks, credit card, credit card payments, Credit Score, Debt, Deceptive Money, interest, investors, loans, penalty, pre-tax, Prudent Money, refinance, taxes, withdraws

I thought that I had seen just about everything when it comes to borrowing money. There are so many crazy programs on the market that end up putting the consumer in a trap. You can watch what is happening in the mortgage markets to get a good example.

Those loan programs were the worst of consumer traps.

Well a company had the bright idea of marketing a program to companies that allows their employees to have a debit card on their 401(k) plan. Now that you can no longer treat your home like an ATM machine, in steps your 401(k) plan.

Here is how it works – An employee gets approved for a loan line. They basically have that amount of money, approved to borrow, waiting to be borrowed for any reason. Interest isn’t charged until the employee takes money out of the account through the use of the debit card. They can take as much or as little as they want.

Then the company who set up the program bills them directly like a credit card. The employee pays a pretty stout interest rate on that money and a nice up-front fee.

There should be watch groups that prevent these types of products from being introduced into the market place. These 401(k) plans should be considered sacred. They are there for an individual’s future. From the standpoint of a loan, borrowing from a 401(k) plan should be in extreme emergency situation where there is just not any other choice.

Retirement saving in America is dangerously low. I am hoping that a program like this does not catch on. The last thing in the world consumers need is the temptation to just take money out as they wish from their 401(k) plan.

Incidentally, when you pay back interest on a loan from your 401(k) plan, you are paying it back with money that has already been taxed. Down the road when you take out that money that was used to pay the interest on your loan, you pay taxes on it a second time.

At least with a 401(k) loan and not this debit card program, you pay yourself back the interest and not out to some company.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.

Tags: 401(k), Bob Brooks, debit card, Deceptive Money, interest rate, loan, mortgage markets, Prudent Money

Most people will tell you that you should always put money in a 401(k) first. It is considered conventional textbook wisdom.

Let’s first think about the phrase “most people” or “the experts” or “they.” People who are successful in investing possess a common trait. They think differently than everyone else. They question how things are supposed to be done. They think outside the box.

So, we are going to think out of the box on this one.

I would suggest that the 401(k) plan has only two benefits. The first is the free matching money. You always want to make sure that you take full advantage of the matching money. If they are going to match dollar for dollar up to the first 4%, then you want to at least put in the first 4%. The second benefit is the ability to put large sums of money back for retirement on a pre-tax basis.

If you are able to put large sums of money back, then the 401(k) plan is probably the best route to take. If not, consider utilizing a Roth for the rest of your contribution.

A Roth gives the greatest tax advantage available by allowing you to never pay taxes again on any money that is deposited. What is the disadvantage? You don’t get a tax deduction on the deposit. Choosing between a small deduction on the initial deposit versus a tax free income down the road is a no-brainer.

This is the beauty of the Roth. Everything that is deposited, as well as the investment growth that you experience until retirement, is all tax-free upon withdrawal.

The other advantage is that you will be able to put back $ 4,000 with an additional $ 1,000 if you are over age 50 for 2007. For 2008, that increases to $ 5,000. What is the drawback? If you are single, your adjusted gross income has to be lower than $ 95,000 to get to invest the entire amount allowable. Over $ 110,000 in adjustable gross income, and you cannot participate. If you are married, that rises to $ 150,000. Over $ 160,000 and you lose the ability to participate.

All contents copyright © 2007 Prudent Money and Bob Brooks. All rights reserved.

Tags: 401(k) Plan, benefits, Bob Brooks, free matching money, pre-tax basis, Prudent Money, Roth IRA, tax advantage

What is the most important priority for your money? Should you save for retirement, eliminate debt, or save for emergencies? Should you attempt to do all three? This is a question that I get frequently through the Ask Bob question and answer section on Prudent Money.

In looking at a person’s financial situation, my initial concern is always the strength of their financial foundation. There are two pillars that hold up that foundation and neither of them have anything to do with invested money. First, is there any debt? And if so, is the debt on a schedule to be paid off quickly. Second, does the person have adequate emergency savings readily available, as well as a plan for that emergency account?

If you run into a problem with debt or you have an emergency, it will not matter if you have money locked up for retirement. You have to be able to take care of the here and now.

So here is the strategy that I would recommend across the board:

1) Put a schedule together to determine how you are going to get out of debt. Make that your number one priority before investing in retirement or anything else. The only exception to that rule would be if there is a 401k match available. You don’t want to not accept free money from your company. This is where you really need to determine what is the most important. Getting out of debt is paramount.
2) Start thinking of a way to handle emergencies. What is going to be your game plan if an emergency were to occur? Now if you follow this formula of liquidating debt at all costs, what are you going to do about emergencies? Now this is where it gets tricky. If you are paying off a credit card where you can borrow the money back if needed, then you aggressively pay off the credit card. If you are paying off a credit card and there is no way of borrowing any of that money back in the event of an emergency, then you need to also make building an emergency fund a priority alongside of getting out of debt.
3) Once your emergency fund is built and you are out of debt, it is time to start thinking about retirement.

Obviously, these rules of thumb will not apply to everyone. However, for most, this ends up being a prudent game plan. If you cannot take care of the present, the future doesn’t matter.

Tags: 401(k), ask Bob, Bob Brooks, Debt, emergency funds, financial foundation, Prudent Money, retirement