The Self-Employed Should Open a Solo 401(k)

I ran some calculations on a self-employed retirement calculator, and as the chart below clearly shows, the Solo 401(k) is a superior retirement plan for the self-employed regardless of income level.  The Solo 401(k) allows self-employed individuals to put more money into a tax-advantaged account while reducing taxable income better than any other retirement vehicle.  

The one advantage the SEP IRA has, is that it can be opened AFTER the tax year has ended.  A SEP IRA can be created as late as April 15th (or as late as October 15th if you extend your tax return) for the previous tax year.  Thus, while the Solo 401(k) is the best way to go, you must open the 401(k) account before the end of your tax year (December 31st). 

Being self-employed means you are both the employee and employer when it comes to retirement plans.  You must create the solo 401(k) account before December 31st and make the employee contribution also before December 31st.  However, the employer contribution can be made as late as April 15th the following year (or October 15th if you extend your tax return).

Self-employed individuals can contribute up to 100% of their compensation to a maximum of $17,500 (plus an additional $5,500 if aged 50+) for their employee portion and up to 25% of net income for the employer contribution up to $34,500 for a grand total combined maximum contribution of $52,000 for 2014 ($57,500 if aged 50+). 

The Retirement Gamble

If you have a 401(k) or IRA or any investments at all, click here for a must-see video "The Retirement Gamble" from last night's FRONTLINE on PBS.  The moral of the story:  When it comes to investing, expenses are your enemy, and index funds are your friends.

During the video, Jack Bogle, the founder of Vanguard and the inventor of the first low-cost index mutual fund, stated that over a lifetime many investors keep roughly one third (1/3) of their investment gains while Wall Street takes two thirds (2/3).  As shocking as it may seem, I wanted to reiterate that Jack Bogle's figures are correct.

Take the following example

Should I invest in a Roth 401(k)? No, probably not.

Many company 401(k) plans have added a Roth 401(k) option.  I believe most people should NOT use the Roth 401(k) option.  The Roth feature seems very appealing since withdrawals from a Roth account can be made tax-free in retirement.  However, these FUTURE tax-free withdrawals come at a high up-front cost since the employee must pay more taxes right NOW.  Let me go through an example and provide an alternative strategy.

Scenario 1:

Take a married couple, 40 years old, with taxable income of $85,000.  This couple would be in the 25% Federal Income Tax bracket and the 7.75% North Carolina State Income Tax bracket.  Let's assume the couple contributes $15,000 per year to a Roth 401(k).  This means the couple is paying an extra $4,912 in income taxes than if they contributed to a traditional 401(k) plan (15,000 x 32.75%).  So, the couple is paying an extra $4,912 for the privilege of placing $15,000 into a Roth account.

Scenario 2:

My suggestion to this couple is to stop making contributions to the Roth 401(k) and instead switch back to the traditional 401(k).  By switching from the Roth 401(k) back to the traditional 401(k) this couple will have an additional $4,912 in take home pay due to the lower income taxes.  The couple should then take that $4,912 in additional take home pay and contribute that money into a Roth IRA (I suggest doing this at Vanguard and use only low-cost index funds).

Does Your 401(k) Plan Leak Money Like a Sieve?

Everyone should pay very special attention to their next 401(k) investment statement.  It is impossible to know how much we pay in fees in many 401(k) plans.  But, new rules issued by the Labor Department will require 401(k) plans to disclose costs for the first time no later than August 30, 2012.

Tip of the hat: Srini Krishnamurthy at NC State.

Feds with Benefits

Apparently, the benefits are so good working for the federal government, that the Congressional Budget Office has determined that federal workers enjoy 16% more in total compensation than workers in the private sector on average.  Most companies no longer offer a pension plan, and many small businesses don't even have 401(k) plans.  But, the federal government has both - and they are good ones.

In my opinion, the federal government offers the best 401(k) plan in the U.S. called the Thrift Savings Plan (TSP).  There is no question the TSP has the lowest expenses among all retirement savings plans.  This is one example of the federal government doing something better than anyone else.  If you want to know how to make the TSP work best for you, check out my book, "The Federal TSP Cookbook."  You can buy it on Amazon.com or BarnesAndNoble.com.

If you buy it direct from my publisher, CreateSpace (<---just click there) and enter this discount code "R82HTEXM" you can buy it for 25% off the list price (about $15).

Feel free to share this discount code and link with everyone you know who works for the federal government.  Happy investing!

Women are Smarter than Men

Many of us have suspected women are smarter than men - here's proof:

According to a survey by the Employee Benefits Research Institute more women employees participate in their firm's 401(k) plan than men.

Women 401(k) participation rate = 55.5%

Men 401(k) participation rate = 53.8%

Perhaps more important is that those stats suggest almost half of all employees aren't saving for retirement.

The stats above are for full-time workers. The gap is even wider for part-timers:

Women: 25.3%

Men: 13.6%

89% of 401(k) investors want help

According to a study by the Boston Consulting Group, 89% of employees want help figuring out how best to invest in their 401(k) plan.  And, 84% want help calculating how much money they need and/or will have at retirement.

Sorry for another blatant self promotion, but that is why I wrote my first book. So, I wonder why "The 401(k) Cookbook" does not sell better?  401(k) investors can figure out the answer to both questions in about a half hour using this book.

Answer: Father of the 401(k)

Question: Who is Ted Benna?

Sorry for the answer/question format. I was watching the TV game show "Jeopardy!" before writing this post.

A good friend of mine sent me a link to an interview with Ted Benna. I had not heard of him, but apparently he was the first person to get a 401(k) retirement savings plan approved by the IRS some 30 years ago. In fact, the reason a 401(k) is called a "401(k)" is because that is the IRS tax code section that created these retirement accounts.

The interesting thing about the interview, is that Mr. Benna does not seem to like how the 401(k) has evolved over time.

What to do when your 401(k) suc(k)s

Here are a couple of good articles that point out there are times when you should NOT participate in your employers 401(k) plan.  SmartMoney article. Ask Holly article.

If your employer's 401(k) plan:

(1) offers no matching funds,

and

(2) charges a commission on your purchases (also called a front-end load, or sales charge),

you should opt NOT to participate in your 401(k).  Instead, fund an IRA or Roth IRA.

If your 401(k) plan charges a commission on purchases, but does offer matching funds, you should only contribute enough to obtain the maximum employer matching funds and no more.

New 401(k) Limit is $17,000 in 2012

The IRS announced several inflation adjustments for retirement plans in 2012. Here are some highlights:

• The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.
• The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
• The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011.  For singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000. 

The IRS also announced several other items to be adjusted for inflation in 2012.