Financial Priorities.

First things first, apparently I’m a little late to the game, but I made a Facebook fan page last night for Punch Debt In The Face (See the new widget in the sidebar on the right?). I don’t really get why that’s better than my Facebook profile page, but for some reason people tell me it is. I also don’t know why likes are important on a page, but again, someone told me they were. Would you take a moment to head on over to my new fan page and gimme a little Likey Likey. If you do, I will…well… do absolutely nothing for you. Sorry, just being honest.

Alright, on to the content…

Do you have an income? Do you have expenses? If you answered yes to either of those questions, you darn well better have some financial priorities in place.

While there are a million different things we could talk about in regards to financial priorities, I want to focus on just one. Which comes first: investing or paying down debt? Hey, speaking of…

Which came first, the chicken or the egg?

Answer: Chuck Norris.

In all seriousness, I think financial priorities are something most of us think we have figured out, but don’t always truly understand. Today I’m going to show you why investing in your 401K is often a better option than paying down high interest credit card debt.

Let’s look at an example:

Jane, makes $50,000 year. She’s 30 years old and her employer fully matches 5% of any contributions she makes to her 401K plan. Jane also has $5,000 in credit card debt, at 15%. What should Jane do, pay down the card as quick as possible, or start building up a nice little nest egg for retirement?

A 15% APR, on a $5,000 balance, means Jane will be paying about $62/month in interest. If she made nothing, but minimum payments, it would take her a little over 22 years to pay that sucker off. She’d also pay $5,729 in interest over that time resulting in a total payment just shy of $11,000. Yikes, that $5,000 original bill became a whole lot more expensive. Better pay that sucker off ASAP, right?

Now let’s examine the investing route.

Jane would be investing $208/month in her 401K if she contributed 5%. Her employer matches that and gives her another $208. If she earned a doable 6% return on this money, and never got a raise in her life, she would end up retiring at age 67 with $683,030 in her 401K. Not bad at all.

If Jane decided to postpone contributing to her 401K, she could use that $208 to make accelerated debt payments each month. But let’s not forget, that 208 number is pretax, so in reality she’d have about $175 extra to throw at her credit card. With the additional payment, Jane will now be credit card debt free in 20 months and will have only paid about $673 in interest. Sounds a heck of a lot better than the 22 years it was going to take in the first example.

Here’s where it gets interesting.

Wanna know what Jane’s 401k would look like if she didn’t start investing until after she became CC debt free? She lost nearly two years of company matching and compound interest, resulting in $596,388 in her 401K. That’s $86,642 less then if she started investing at age 30.

Guys and girls, this point is SOOOO important it can not be overlooked. It is absolutely in Jane’s best interest to start investing in her companies 401K, even though she is not debt free. If she waits until she has her credit card paid off, she loses a crap load of money. I know this seems to go against the grain. Credit card debt is evil, don’t get me wrong, but that doesn’t mean it should always be at the top of our financial priorities.

Obviously, in a perfect world you will have enough discretionary income that you can not only contribute to your retirement, but also pay down your debt quickly. I always have been, and always will be a DEBT PUNCHER, but only when it is in your best interest.

Does your employer offer a 401K match? (I’d like as many people as possible to answer this question since I’ve heard a lot of the retirement benefits in the private sector have been getting cut left and right). Are you taking full advantage of that match? If not, you’re stupid. I’m sorry, you just are. You are literally giving up FREE money. In Jane’s situation would you go the way of Dave Ramsey and still pay down your credit card first, or would you let number’s guide you and start contributing to your retirement?

p.s. Like me on Facebook, I’m desperate 🙂

Retire early and withdraw from your 401k without penalty.

Remember that time I wrote a post about why I hate my Roth IRA and why I would probably never contribute to it ever again.

But then, like a week later, I wrote a follow-up post saying I still hate my Roth IRA, but I’ll probably keep contributing to it for the foreseeable future.

Or how about that time, a few weeks ago, when I wrote a post about having a ton of money available to me at retirement, maybe even too much?

But then my most recent post talked about how I was going to add even more to my retirement accounts, specifically my 401k.

 

This personal finance stuff can be confusing

What might sound good one week, may not be my cup of tea the following week.

With a government pension waiting for me on my 57th birthday, and social security kicking in shortly after, I’ve always just kind of resigned to the fact that I would work in to my late 50’s.

I mean, I’ll never make a huge salary in my line of work, so the idea of retiring early seemed like a foreign concept.

 

A Changed Perpective

But after reading J Money’s recent post on Early Retirement, and poking around with the spreadsheet he made, I found myself wanting to dig deeper.

According to J’s spreadsheet, if I change nothing about our spending (or saving) habits, I’m looking at being able to retire when I’m 45 years old. Check it…

early retire

Basically, the early retirement rule of thumb is you need to have 25 times annual expenses banked before you can retire.

Since our plan is to spend about $48,000 per year, we need $1.2 million stored away before I can call it quits. As soon as I hit that number, I can work my last day with reasonable certainty that I wont have to work ever again.

So the question remains, even if I had $1.2 million invested in my 401k right now, how could I possibly access those funds without paying the an IRS mandated 10% penalty for early withdrawal?

 

Introducing the IRS 72t withdrawal program. 

Without boring you to death, the 72t program allows an individual to withdraw an “equally substantial distribution” each year without paying a penalty.

Basically, if I have $1,200,000 in my retirement accounts by the time I turn 35 years old, I could take advantage of the 72t program and withdraw $56,420 from my 401k each year without paying a penalty.

There are, of course, a few catches to the 72t program. One of the most important being that you are required to continue making withdrawals until age 59 1/2 or for five years, whichever time period is longer. So no withdrawing some years, and not withdrawing others. It’s definitely a long term commitment for those that choose to retire early.

But hey, how bad can retiring early really be? 

Another big whopper for the program, is that if you modify your series of payments in any way, the 10% early distribution penalty is retroactively imposed on all money you’ve withdrawn. Ever. Yikes! That would be a very costly mistake.

Basically, once you pick an amount to withdraw each year (in this example $56,000), you have no wiggle room to withdraw any amount other than that from your 401k.

If you want to learn more about the 72t rule you can do so here. 

Some other things worth noting 

So far I’ve only been talking about withdrawals from my 401k, but as you all know, I’ve also been an avid contributor to my Roth IRA and most recently, a taxable investment account.

Having my retirement portfolio diversified across a number of avenues sweetens the pot. With the 72t rule and my example above, I was only allowed to take out $56,000 a year.

No more, no less. 

But what if I have Girl Ninja and I decide to buy a new car, or pay for Baby Ninja’s first year of college, or a potential future daughter’s wedding. Where is the money for those types of things going to come from?

My Roth IRA. Duh.

I’ll be able to use my Roth as a means to buffer any abnormal spending requirements. Because, as I’m sure you already know, Roth contributions can be withdrawn at any time.

Or in other words, I’d have about $75,000 of tax-free/penalty-free money accessible to me at any given time by my 35th birthday.

 

But wait there’s more. 

As you might recall from my post on Home Equity Lines of Credit, Girl Ninja and I have decided to stop keeping so much darn cash in the bank and begin throwing all our discretionary income in to our taxable investment account.

That’s right. Screw our savings account!

As our taxable investment account continues to grow, I can take advantage of all sorts of tax loop holes to to minimize my tax obligation on withdrawals, possibly even completely eliminating taxes altogether. Tax loss harvesting anyone? Or how about dividend investing? The loop hole list goes on and on.

Don’t believe it’s possible?

You’re wrong. Check out this inspirational blog post from a couple that paid NO TAXES in 2013.

 

It’s time you start drinking the kool-aid!

Like I said before, I’d always assumed early retirement was for two types of people.

Either the mega wealthy for obvious reasons.

Or

People like Mr Money Mustache, who live such a frugal lifestyle that they spend less than $25,000 per year. (editor’s note: Nothing wrong with the frugal and resourceful lifestyle, I personally am just not as interested in giving up my vehicle, moving to a cheaper cost of living area, growing my own food outback, etc. I’m lazy in that respect and am willing to pay the premium for it I suppose.)

Now that I’m digging deeper and getting in to some of the nitty gritty aspects of personal finance, my eyes are open to a whole new way of thinking. While I might not be retiring at 35 like the examples above, I could see 45, or maybe even 40 being a real possibility. And I don’t know about you, but that sounds a heck of a lot better than retiring at 57 like I’d always planned on.

 

P.S. I’m aware the future will obviously have some expensive seasons ahead (multiple children in high school, potential house projects, big family vacations, etc), but we will also have seasons of reduced expenses or greater income(paying off our mortgage, kids moving out and becoming self-sufficient, Girl Ninja going back to work, pension, social security, etc). 

Preparing for Retirement: Top Tips for Making Money-Smart Moves

For many in the UK, retirement is an anxious time. On the one hand, you can’t wait until you can stop working. On the other, you’re worried about living on a fixed income. You worry about your pension, your personal savings, your insurance, and what you’ll do about rising healthcare costs.

Here’s what you need to know to make smarter money moves and survive when it’s time to hang up your work shirt forever.

Scoping Out Your State Pension – What You Need To Know

Your state pension is the minimum amount of money you’re entitled to during your retirement. You can claim a state pension when you reach your state pension age. Check out when you’ll reach that age on Gov.UK’s state pension calculator.

You can also consider putting off your claim if you want to stay working longer. This deferral of your pension accumulates your pension benefits until you’re ready to retire.

Buy More Life Insurance

Most people don’t think of buying life insurance as a retirement strategy, but it’s a secret that big banks and hedge funds employ all the time. For the individual retiree, the reasoning stems from a somewhat forgotten approach to financial planning taught by Dr. Solomon Stephen Huebner at the Wharton School of the University of Pennsylvania in America, during the early 1900s.

His concept of Human Life Value stated that an individual should purchase permanent life insurance to fully insure the value of his life – forever – and that human life is the ultimate property, and source of all other properties, which needs infinite protection.

Just as one does not ever reduce the amount of home insurance, auto insurance, or liability insurance over time, regardless of one’s bank account size, one should never reduce the amount of life insurance in force on one’s life.

And, because permanent life insurance includes cash surrender values, it can be used to supplement your pension benefits at retirement.

The cash values in a life insurance policy grow at guaranteed rates, are tax-free, and participating or “with profits” policies pay dividends which may be used to supplement other income sources.

If structured properly (you should talk to a life insurance agent about this), your policy will provide significant protection against stock market losses or corrections, give you options to draw an income during a recession or depression, and the savings component of permanent insurance is accessible for any reason during your lifetime.

Consider a Lump Sum Annuity

When you retire, it’s tempting to take your pension as a lump sum. And, in the UK, you can withdraw up to 25% of your pension pot for this purpose. But, what should you do with it? That depends on your total financial plan.

However, a popular option is to annuitize the lump sum.

Annuitization means that you exchange your savings for guaranteed monthly income. You no longer have access to that savings, but you do have an income you cannot outlive.

Make Smart Cuts

The important thing here is to make cuts in your lifestyle that will not interfere with your long-term goals or activities which you have been planning a lifetime for. Many people get to retirement and suffer from a condition where they are tasked with reducing their lifestyle.

This is something that most people find unappealing for obvious reasons. Because you’re not making an income subject to regular raises anymore, some smart cuts are in order. But, those cuts shouldn’t interfere with your ideal life.

In most cases, this requires a little creativity. If part of your retirement plan was to travel, for example, you could compromise on the size of your home, selling it and rent a flat in a low-cost neighbourhood.

Or, at least buy a smaller home.

Then, you could travel in relative freedom with the money from the sale of the house, or at least part of that money.

Another way to save money would be to not travel. If travelling wasn’t part of your retirement dream, then you could work on other ways to cut expenses. You could still downsize your home, but perhaps you could also buy a bicycle and sell your vehicle.

This will help you stay active and reduce transportation costs.

If you can’t ride everyday, you could downsize your vehicle by buying an older model or work out a ride-sharing agreement with a friend of relative. Or, pay for ride-sharing through any of the popular ride-sharing services on the market now.

Joel Rowe works in the personal finance industry within the pensions sector. He has growing concerns on the futures of baby boomers and likes to write on the topic in the hopes of helping people live better lives once they reach retirement.

This is why you buy when the market is breaking records

The Nasdaq hit an all time high yesterday, ending the day at 5,056. The previous record dated back to March 10th 2000, when the index was at 5,048. As you can guess, the previous record was set shortly before the dotcom crash that sent the Nasdaq down nearly 4,000 points to 1,114 in 2002.

The S&P 500 set an intraday high yesterday, but closed just a few points shy of a new record.

Looking at the Dow, we find an equally bubbly story…

Screen Shot 2015-04-23 at 10.33.58 PM

The low in 2009 was 6,626. Today we’re at 18,058. That’s an insane roller coaster that has been climbing aggressively for the last six years.

THIS BUBBLES GOING TO POP! 

But guess what. You should probably keep investing in the market anyways. In fact, this is the exact way the market is supposed to work. Although there are peaks and valleys, the market trend has always been in an upwards direction. ALWAYS.

Sure, we have a recession (or depression) every decade or two, but these occasions are always followed by a lengthy period of gains. For every two to four years of losses, we average five to ten years of gains.

The market highs are getting higher, which means the lows get higher too when the crash finally comes. It’s a beautiful thing.

WHY you BUY in a bubble. 

In June 2013, I wrote a post titled I might take out a $30,000 401k loan just to piss some of you off. I was thinking of borrowing from my 401k and one of the primary draws was that the market was trading at all time highs (the Dow was at 15,000 for the first time ever). Why wouldn’t I want to lock in the sexy appreciation I had earned?

Fortunately, I was too chicken to take out the loan. Thank goodness considering the market has shot up another 20% since that post.

No one can time the pop.  

The problem isn’t with identifying when the market might be in a bubble. It arguably is right now.

Problems come when you try and preempt the bubble’s pop. You could sell today thinking things are crazy overvalued, only to find out this gravy train goes on for another three years before there is a correction.

This is why I need to constantly remind myself that I should think about my investments like I think about my marriage.

To have and to hold from this day forward. 

In sickness and in health. 

In good times and bad times. 

For richer or poorer. 

Until death does us part.

I will contribute to my investment accounts. 

You NEED to know your expense ratios.

throw money in toiletNow that I’ve given our savings account the cold shoulder in hopes of building long-term wealth via our taxable and retirement accounts, basic investment strategies just wont cut it any more.

The need to go deeper.

In 2007, when I landed my current job with the Feds, I was handed a fat stack of HR paperwork as part of my new hire packet. One of the pieces of paper in this stack asked if I wanted to begin contributing to the government’s version of a 401k, known as the Thrift Savings Plan (TSP).

The paper told me that if I contributed 5% of my salary, the government would match that contribution and throw in an additional 5% on my behalf.

I didn’t have to be a savvy investor to know that a 100% return on investment was an incredible opportunity.

The TSP is nice in that it only has five funds that one can choose to invest in. They are…

  • C Fund: Essentially an S&P 500 index fund
  • S Fund: A total US stock market index (so companies the S&P doesn’t cover)
  • I Fund: An international fund that mimics a Morgan Stanley International fund
  • F Fund: A broad index representing the US bond market.
  • G Fund: A guranteed return fund. Currently about 2% ROI. 

For all of the bureaucratic red tape and politics that comes with the government, you sure can’t beat the simplicity of the TSP.

But the thing that puts the TSP miles ahead of the competition, likely even your 401k plan, is the expense ratios.

If you’re a super passive contributor to your retirement accounts you might not even know what expense ratios are.

Without boring you to death, expense ratios are a fee that you pay the organization that manages your investment account. You may not have known these expenses existed because you don’t pay them out of pocket, instead your organization just debits them from your account.

Know your expense ratios. 

It could literally mean the difference of tens (or hundreds) of thousands of dollars over the course of your accounts life.

For example, the TSP charges expense ratios of 0.029%. Or in other words, for every $1,000 you have in your TSP, they will deduct 29 cents, annually.

Whereas, if you have an actively managed account, it isn’t uncommon to have expense ratios of 1%, or in other words $10 is deducted for every $1,000 invested, annually.

Ten dollars a year might not seem like a lot, but OH BOY does it add up quick.

Impact of Expense Ratios over the long term

For the sake of making everything easy, let’s say you have $100,000 in your 401k right now. You add $10,000 to your account each year. You are planning on earning an 8% return on investment over the next 30 years.

Take a look at how an account with a 0.030% expense ratio absolutely DESTROYS an account with a 1.0% expense ratio.

Screen Shot 2015-03-04 at Mar 4, 2015, 10.30.57 PM

So while a 1% expense ratio may not seem like a lot up front, man-oh-man does it cost ya big bucks in the long run, $419,181.44 to be exact.

Why pay an organization $420,000, when you could keep all that money for yourself? 

I’m fortunate that the TSP has insanely low expense ratios. It would be stupid of me to not contribute as much as I can each year to take advantage of the low fees (hence the reason I’m hoping to max my contributions this year).

And the good news is, even if I quit working for the Feds, I still get to keep my TSP. This will be one account I will probably never get rid of.

“But Ninja I don’t work for the Feds.”

You ever heard of Vanguard? Of course you have! It’s universally known as being one of the most legit investing institutions in the universe (think the Costco of investing).

Vanguards expense ratios are really cheap compared to most of their competitors (although still two to five times that of the TSP).

The more money you have, the better rates you will get.

From 2007 to 2014, I was contributing to VTSMX, which is Vanguards version of a broad based stock market fund. The expense ratio was 0.17%. Not too shabby.

But now that I’m committed to not being such an investing dummy, I’ve sold all $30,000 of that fund and bought VTSAX, which is EXACTLY the same fund, but has an expense ratio of 0.05% (1/3 of VTSMX). The catch with VTSAX is that you have to have a minimum of $10,000 to invest in this account to qualify for the cheaper fee.

Had I left my money in the more expensive VTSMX, I would have paid $22,000 more in fees over the next thirty years.

THAT IS SOOOOOOOOOOOOOOO STUPID. 

So, seriously, if you haven’t thought twice about your investment (taxable and retirement) accounts’ expense ratios; you need to get off my web site and start doing some research (especially because your employer might have some really sucky options).

Not doing so could LITERALLY cost you a fortune.

*make sure you consider tax implications on realized gains if you sell investments from a taxable account. 

For Oh Won Kay.

In the blink of an eye, my overtime income that I blogged about two days ago is gone. Rest in peace, hopefully we will meet again.

Where did it go?

I’m glad you asked.

As soon as I learned the opportunity for overtime was available, I immediately began deciding how to purpose this new found income.

And like a true personal finance nerd, the result was about the most boring thing you could possibly imagine.

My 401k. 

While I’d like to pretend you didn’t see that coming, I imagine you nerds would have been just as nerdy and probably done the same nerdy thing.

Seeing that I have no idea how long this overtime option will be available to me, I want to make sure I take advantage while I can.

For now that means I’ll be throwing $1,600/month in to my 401k instead of the $600/mo I have been doing.

Since my agency matches 5% of my income each month, I have to be careful about how fast I max out my 401k.

If I hit the $18,000 limit by, let’s say August, then I would no longer be allowed to contribute to my 401k for the rest of the year (September to December). Which means, my agency wouldn’t be able to provide me a 5% match (since I’d no longer be contributing).

Or in other words, I’d lose out on about $2,000 of 100% FREE MONEY.

No way in heck I’m going to let that happen, so even though the overtime I’m working should theoretically gross me an additional $2,400/mo. I’ll only be throwing in $1,600 towards my 401k.

Leaving me with about $600ish dollars to tinker around with after tax.

To make sure things don’t get too exciting around these parts, I’ll probably just set up an auto-transfer and have that extra money go straight to my brokerage account.

Sexy by the worlds standards? Hardly.

Sexy by not-being-an-idiot-with-new-found-money standards? Absolutely. 

How much will I have when I retire?

One of the perks of working for the federal government is access to a pension once I reach my minimum retirement age. Since I was born after 1970, I’ll be eligible to retire on my 57th birthday. Assuming I spend my entire working career with Uncle Sam (I’ve been on board since I was 22), this will give me 35 years of credible service.

For the sake of keeping things simple, let’s also assume I never get a promotion or apply for a higher paying position within the government.

Since the federal government pay system is very structured I know exactly what my salary will be for the remainder of my professional life (except for inflationary adjustments over the years).

While I wish I had more control over my earning potential, instead of being forced to accept what congress mandates, a predictable income does come with one benefit.

It allows me the ability to make relatively accurate predictions as to what my retirement income might look like 28 years from now.

I used this Federal Ballpark Estimator provided by the government to figure out exactly how much I will have waiting for me come retirement.

Look out a lot of numbers are coming your way (skip past this section if you just want to see what this all means).

 

Here are my Baseline Stats/Assumptions:

Current Age: 29 y.o.

Retirement Age: 57 y.o.

Estimated age of death (creepy to guess this): 87 y.o.

 

Income and Current Retirement Assets:

Maximum wage possible in current job: $97,370

Current 401K Balance: $87,000

Current IRA balance(s): $98,000

Investment/Inflation Assumptions:

Percent of income put in 401k: 10%

Percent Matched by Govt: 5%

401k and IRA annuity rate: 3.5%

After tax income invested annually: $10,000 ($5,500 for Roth, $4,500+ for taxable)

Inflation Rate: 3%

Inflationary Wage Raises: 2.75%

Rate of Return BEFORE Retirement: 6%

Rate of Return IN Retirement: 4%

Percent of current income needed in retirement: 75%

 

Alright enough with the boring numbers that need to be put in to the calculator. Let’s see how this all translates when it comes time for 57-year-old Ninja to retire, shall we?

Pension Benefit in today’s dollars: $31,301 annually / $2,608 monthly

401K Balance in today’s dollars:  $771,870 total balance / $2,615 monthly

IRA Balances in today’s dollars: $612,719 total balance / $2,076 monthly

So with my relatively conservative estimations I should be bringing in about $7,299 per month($87,588 annually) in today’s dollars if I quit on my 57th birthday and never work another day.

When I turn 62, Social Security would theoretically kick in, and if it does, I’ll have an additional $1,782 in monthly income available to me. For a grand total monthly income of $9,081 ($108,000 annually).

DO YOU KNOW WHAT THIS MEANS!!!! 

It means retired Ninja will be making more money per month than working Ninja ever will. I find a lot of comfort and freedom in that information. Especially considering my draw down rate should about match my funds performances and therefore my retirement portfolio will never decrease in value.

I’ll get to live comfortably in retirement with virtually no financial worries and either make a few big splurges late in life, or leave a $1,000,000 dollars (in today’s dollars) for my kids when I die.

In the words of Paris Hilton…

paris hilton