7 Pros and Cons of Investing in a 401(k) Retirement Plan at Work

A 401(k) retirement plan is one of the most powerful savings vehicles on the planet. If you’re fortunate enough to work for a company that offers one (or its sister for non-profits, a 403(b)), it’s a valuable benefit that you should take advantage of.

But many people ignore their retirement plan at work because they don’t understand the rules, which may seem confusing at first. Or they worry about what happens to their account after they leave the company or mistakenly believe you must be an investing expert to use a retirement plan.

Let's talk about seven primary pros and cons of using a 401(k). You’ll learn some lesser-known benefits and get tips to save quickly so you have plenty of money when you’re ready to kick back and enjoy retirement.

What is a 401(k) retirement plan?

Traditional retirement accounts give you an immediate benefit by making contributions on a pre-tax basis.

A 401(k) is a type of retirement plan that can be offered by an employer. And if you’re self-employed with no employees, you can have a similar account called a solo 401(k). These accounts allow you to contribute a portion of your paycheck or self-employment income and choose various savings and investment options such as CDs, stock funds, bond funds, and money market funds, to accelerate your account growth.

Traditional retirement accounts give you an immediate benefit by making contributions on a pre-tax basis, which reduces your annual taxable income and your tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.

Roth retirement accounts require you to pay tax upfront on your contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free. A Roth 401(k) or 403(b) is similar to a Roth IRA; however, unlike a Roth IRA there isn’t an income limit to qualify. That means even high earners can participate in a Roth at work and reap the benefits.

RELATED: How the COVID-19 CARES Act Affects Your Retirement

Pros of investing in a 401(k) retirement plan at work

When I was in my 20s and started my first job that offered a 401(k), I didn’t enroll in it. I was nervous about having investments with an employer because I didn’t understand what would happen if I left the company, or it went out of business.

I want to put your mind at ease about using a 401(k) because there are many more advantages than disadvantages.

I want to put your mind at ease about using a 401(k) because there are many more advantages than disadvantages. Here are four primary pros for using a retirement plan at work.

1. Having federal legal protection

Qualified workplace retirement plans are protected by the Employee Retirement Income Security Act of 1974 (ERISA), a federal law. It sets minimum standards for employers that offer retirement plans, and the administrators who manage them.

ERISA offers workplace retirement plans a powerful but lesser-known benefit—protection from creditors.

ERISA was enacted to protect your and your beneficiaries’ interests in workplace retirement plans. Here are some of the protections they give you:

  • Disclosure of important facts about your plan features and funding 
  • A claims and appeals process to get your benefits from a plan 
  • Right to sue for benefits and breaches of fiduciary duty if the plan is mismanaged 
  • Payment of certain benefits if you lose your job or a plan gets terminated

Additionally, ERISA offers workplace retirement plans a powerful but lesser-known benefit—protection from creditors. Let’s say you have money in a qualified account but lose your job and can’t pay your car loan. If the car lender gets a judgment against you, they can attempt to get repayment from you in various ways, but not by tapping your 401(k) or 403(b). There are exceptions when an ERISA plan is at risk, such as when you owe federal tax debts, criminal penalties, or an ex-spouse under a Qualified Domestic Relations Order. 

When you leave an employer, you have the option to take your vested retirement funds with you. You can do a tax-free rollover to a new employer's retirement plan or into your own IRA. However, be aware that depending on your home state, assets in an IRA may not have the same legal protections as a workplace plan.

RELATED: 5 Options for Your Retirement Account When Leaving a Job

2. Getting matching funds

Many employers that offer a retirement plan also pay matching contributions. Those are additional funds that boost your account value.

Always set your 401(k) contributions to maximize an employer’s match so you never leave easy money on the table.

For example, your company might match 100% of what you contribute to your retirement plan up to 3% of your income. If you earn $50,000 per year and contribute 3% or $1,500, your employer would also contribute $1,500 on your behalf. You’d have $3,000 in total contributions and receive a 100% return on your $1,500 investment, which is fantastic!

Always set your 401(k) contributions to maximize an employer’s match, so you never leave easy money on the table.

3. Having a high annual contribution limit

Once you contribute enough to take advantage of any 401(k) matching, consider setting your sights higher by raising your savings rate every year. For 2021, the allowable limit remains $19,500, or $26,000 if you’re over age 50. A good rule of thumb is to save at least 10% to 15% of your gross income for retirement.

Most retirement plans have an automatic escalation feature that kicks up your contribution percentage at the beginning of each year. You might set it to increase your contributions by 1% per year until you reach 15%. That’s a simple way to set yourself up for a happy and secure retirement.

4. Getting free investing advice

After you enroll in a workplace retirement plan, you must choose from a menu of savings and investment options. Most plan providers are major brokerages (such as Fidelity or Vanguard) and have helpful resources, such as online assessments and free advisors. Take advantage of the opportunity to get customized advice for choosing the best investments for your financial situation, age, and risk tolerance.

In general, the more time you have until retirement, or the higher your risk tolerance, the more stock funds you should own. Likewise, having less time or a low tolerance for risk means you should own more conservative and stable investments, such as bonds or money market funds.

RELATED: A Beginner's Guide to Investing in Stocks

Cons of investing in a 401(k) retirement plan at work

While there are terrific advantages of investing in a retirement plan at work, here are three cons to consider.

1. You may have limited investment options

Compared to other types of retirement accounts, such as an IRA, or a taxable brokerage account, your 401(k) or 403 (b) may have fewer investment options. You won’t find any exotic choices, just basic asset classes, including stock, bond, and cash funds.

However, having a limited investment menu streamlines your investment choices and minimizes complexity.

2. You may have higher account fees

Due to the administrative responsibilities required by employer-sponsored retirement plans, they may charge high fees. And as a plan participant, you have little control over the fees you must pay.

One way to keep your workplace retirement account fees as low as possible is selecting low-cost index funds or exchange-traded funds (ETFs) when possible.

One way to keep your workplace retirement account fees as low as possible is selecting low-cost index funds or exchange-traded funds (ETFs) when possible.

3.  You must pay fees on early withdrawals

One of the inherent disadvantages of putting money in a retirement account is that you’re typically penalized 10% for early withdrawals before the official retirement age of 59½. Plus, you typically can’t tap a 401(k) or 403(b) unless you have a qualifying hardship. That discourages participants from tapping accounts, so they keep growing.

The takeaway is that you should only contribute funds to a retirement account that you won’t need for everyday living expenses. If you avoid expensive early withdrawals, the advantages of using a workplace retirement account far outweigh the downsides.

Source: quickanddirtytips.com

Should I stay or should I go? Wrestling with the decision to quit a career

J.D.’s note: In the olden days at Get Rich Slowly, I shared reader stories every Sunday. I haven’t done that since I re-purchased the site because nobody sends them to me anymore. But earlier this year, Mike did. I love it. I hope you will too.

Earlier this year, I sent my wife a text message: “On a scale of 1 to 10, how freaked out would you be if I quit my job this afternoon?”

My wife and I had only been married a short while, but she’d known since our second date that I didn’t plan to work in my traditional job until normal retirement age. She also knew that I hadn’t been very happy at work in recent months.

We’re very compatible financially — both savers raised in working-class families that didn’t always have a lot. We make a point of having what we like to call “Fun Family Finance Day” from time to time. On Fun Family Finance Day, we do everything from competitively checking our credit scores to discussing questions that get at the root of our money mindsets to help us create our goals.

But this question wasn’t part of the plan. Not then.

And it was never on any of the lists of questions that we’d discussed with each other. It was like a pop quiz, a pothole in the smoothest relationship road I’d ever traveled…and I was the one putting it there.

Dreams Remain Dreams Without Doing

My wife and I rarely argue, but when we do it’s usually about food. It’s the kitchen and the grocery store that are our battleground. Our finances are fine. Thankfully, when you’re confident in the life you’ve created and the person you chose to build it with, it’s a lot easier to be honest about what’s on your mind.

That still doesn’t always mean you get the answer you want. Or the answer you were expecting. She responded: “Wait what. Kinda. What would you do?”

A completely reasonable and fair question. Not to mention one that I’d probably have to get comfortable answering from a lot more people.

I think my immediate reaction was: We talk about this stuff all the time, where is my, “No worries baby, YOLO!”? (I must have watched too many romcoms back before we cut cable from our lives.)

Being a grownup, it turns out, is actually really hard sometimes. I was about to learn that talking about something, and actually doing it, are a world apart.

Life is full of dreamers and doers. Sometimes those two personalities cross over. But there are plenty of people who go through life talking about so many things they’ll never have the courage to try — or the discipline and determination to follow through with.

Which person was I? The dreamer? The doer? Or that fortunate combination of both?

Standing on the Ledge

There’s a quote perched atop my bucket list of long-term goals:

“At some point, you will need to take a long look in the mirror and ask yourself not just if this is something you wanted to do at one point, but if this is something you will want to have done.”

Words are meaningless without action. It was time for me to take that long look in the mirror. I thought back to one of the questions that my wife and I had previously discussed: What does money mean to you? To me, once I grew out of the “stuff accumulation” phase of my early- to mid-20s, my answer had always been freedom. Money meant freedom. To my wife, the answer was security. Money meant security.

You can probably see how freedom can conflict with security. That was the case here. Not only that, but I was asking to change the perfect plan, one that she was comfortable with and excited about.

That’s not one, but two shots against financial security. If I’d thought more about our financial blueprints and how they differ, I might have seen this coming from a mile away!

As I was standing on that ledge, about to quit my job, thoughts started to race through my mind. What did I actually have to lose if made the leap? Lots.

  • A happy relationship and marriage.
  • A secure job with solid income, not to mention a sixteen year investment in my career.
  • Great benefits, including lots of time off, health insurance, 401(k) — even a pension.
  • The ability to afford anything at any time without any real worry. (Our finances were already on autopilot.)
  • My work friends and work prestige.
  • The general day-to-day purpose of a job.
  • The opportunity to create generational wealth. If we worked until 65, the power of compounding would likely make us ridiculously wealthy.

Today at Get Rich Slowly, let’s perform a little exercise. Come stand in my shoes for a minute, won’t you? Join me on the ledge. Do you see the beautiful view? The endless opportunity? The excitement that’s felt only at the beginning of a grand adventure, an adventure where anything is possible?

Or do you get a queasy feeling in your stomach? Do you feel like you’ve lost your balance, like you’re on the edge of some great catastrophe? Do you see a frightening fall from grace? Does it make you want to back away immediately?

Let’s go back to what it felt like to make this decision…

Sitting on the ledge

My Situation

I’m 38 years old. I’ve worked for the same company since I was 22. Corporate insurance is all I know. I’m well paid. I work from home for a solid company with good benefits, plenty of time off, and I really enjoy most of the people I work for and with.

It’s the definition of stability — a solid guardrail protecting me from what lies over the ledge. So what’s the problem?

A year ago, I took a new position that seemed like a great opportunity. Only it wasn’t. The first misstep of my career. A year in, that spot has killed my enthusiasm and engagement. For the first time at work, I’m struggling to get things done.

As an extrovert that derives meaning from helping others, this feels like a prison. My job isn’t hard because it’s stressful. It’s hard because it’s boring me to death! And what are any of us doing thinking about personal finance and early retirement if we aren’t trying to make better use of our limited time on this planet?

There’s a project looming that would require some weekend work once in a while for the foreseeable future, I’ve avoided it in the past, but my luck is running out. My team — and, more importantly, my position — need to take it on. I understand completely. I just don’t want to do it.

At this point in life, my time is way more important to me than money. The weekends and vacations are what I live for. Adventures in the mountains with my friends, quality time with my wife, our dog, and our families – that’s what makes me feel alive.

Insurance? Meh.

No little kid ever said they wanted to work for an insurance company and play with spreadsheets and Powerpoint presentations when they grow up. I wanted to be a baseball player, a sports writer, even a professional forklift driver. (Because what’s more badass than a forklift when you’re a little kid and your dad works at a marina?)

A Glimpse of the Other Side

My wife and I just got back from a delayed honeymoon to Alaska. To say it was incredible would be an understatement. Denali. Kenai. Majestic train rides. Fjords. Glaciers. Bears. Bald eagles. Whales. Hikes.

Life slowed down.

I somehow managed to read five books while doing so many other amazing things. During our more than two weeks off, I got to see what my mind was capable of when it wasn’t drowning in useless information and mundane tasks that consume my braindwidth.

We talked to people who had ended up in this wild place through a history of taking risks. Parents that had hitchhiked cross-country and ended up there back in the 70s. Can you imagine? Where we live, a fair number of people never leave their town or state!

Before the trip, I had tried to apply for a few positions. For whatever reason, it just didn’t work out. I came home from an amazing glimpse into what life could be to a job that seemed like the polar opposite. (Isn’t that every vacation though?) I’ve felt like a square peg trying to fit in a round hole for a while now. Maybe normal life just isn’t for me anymore. Maybe I need something just a little less ordinary.

Should I Stay or Should I Go?

I’ve been practicing the classic tenets of personal finance since I was in my mid- to late-20s. I found an awesome woman in my mid-30s who just happens to be down with this lifestyle as well. We’re probably two to three years short of where we want to be based on our master plan of a fully-paid house and a really comfortable number in invested assets.

We’d likely fall somewhere between Agency and Security on the stages of financial freedom.

I know good jobs don’t grow on trees, especially where we live. The seasons of the economy are always shifting and there’s a chill in the air. Economic winter can’t be too far off. My wife still has a solid job, and we live a pretty simple life — albeit in an expensive part of the country. Our main splurge is travel, but otherwise we live well below our means.

All of this knowledge and preparation comes with a cost. Having options can be a burden too, because then you’re responsible for making hard decisions. And you’re responsible for the outcomes of those choices.

What other options are there?

  • Be a crappy employee/teammate, and still get paid? Plenty of people have played that game. Get a surgery or two, go out on leave, let performance management run its course for however long that takes, and keep cashing checks the whole time. I don’t think I have it in me to put people I respect through that. It’s just not who I am.
  • I work from home, and I still can’t bring myself to abandon my laptop. What if someone needs me?
  • Am I giving up too soon? The finish line seems just around the corner — somehow so close yet so far away.
  • Should I just suck it up and sell a little more of my soul? Slump my shoulders a little bit more as I trade another piece of myself for money I don’t need to buy things I don’t want?

As I go back and forth, sometimes I briefly wish I’d never found the personal-finance community. Like Neo in The Matrix, why’d I have to take the damn red pill? Being a mindless consumer wasn’t so bad. I would have invested 6-10% in my 401(k) with a traditional pension on top of it.

Forty years on autopilot would have produced a comfortable life of work, nice things — and maybe some time in old age to relax and travel.

Facing Freedom

The whole point of everything I’ve done since I started this journey was to be in control of my own life. To not be owned by things or circumstances. To have options. Freedom of choice. F-U money.

I have the corporate battle scars and survivor’s guilt to understand why that’s important.

I’ve sat on the phone while I heard that my old department was closing down. The sadness and tears in the room. Everyone that had taken me in, given me my chance, taught me the job…basically gone, casualties of a business decision.

I’ve seen people get laid off who are petrified because they don’t know how they’ll pay their bills in a couple of weeks. People will be okay eventually though, right?

What about my friend who was struggling last year and left the company? He committed suicide a few months later. Maybe everyone won’t be okay eventually. Depression runs in my family. Am I really built for this? That thought is haunting.

It’s been said that one of the hardest decisions you’ll ever make in life is whether to walk away or try harder. Every bone in my body tells me it’s time to walk away, to bet on myself.

The End?

About six months after the text exchange that blindsided my wife, with her support, I hit send on the scariest, most exciting and important one-line email of my professional career. It would also signify the unofficial end of it: “I will be resigning from my position effective Wednesday, June 26th.”

To combine a few lines from my favorite movie, The Shawshank Redemption, some birds just weren’t meant to be caged. It’s time to get busy living, or get busy dying.

Source: getrichslowly.org

529 Plans: A Complete Guide to Funding Future Education

Do you have kids? Are there children in your life? Were you once a child? If you plan on helping pay for a child’s future education, then you’ll benefit from this complete guide to 529 plans. We’ll cover every detail of 529 plans, from the what/when/why basics to the more complex tax implications and investing ideas.

This article was 100% inspired by my Patrons. Between Jack, Nathan, Remi, other kiddos in my life (and a few buns in the oven), there are a lot of young Best Interest readers out there. And one day, they’ll probably have some education expenses. That’s why their parents asked me to write about 529 plans this week.

What is a 529 Plan?

The 529 college savings plan is a tax-advantaged investment account meant specifically for education expenses. As of the passage of the Tax Cuts and Jobs Act (in 2017), 529 plans can be used for college costs, K-12 public school costs, or private and/or religious school tuition. If you will ever need to pay for your children’s education, then 529 plans are for you.

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529 plans are named in a similar fashion as the famous 401(k). That is, the name comes from the specific U.S. tax code where the plan was written into law. It’s in Section 529 of Internal Revenue Code 26. Wow—that’s boring!

But it turns out that 529 plans are strange amalgam of federal rules and state rules. Let’s start breaking that down.

Tax Advantages

Taxes are important! 529 college savings plans provide tax advantages in a manner similar to Roth accounts (i.e. different than traditional 401(k) accounts). In a 529 plan, you pay all your normal taxes today. Your contributions to the 529 plan, therefore, are made with after-tax dollars.

Any investment you make within your 529 plan is then allowed to grow tax-free. Future withdrawals—used for qualified education expenses—are also tax-free. Pay now, save later.

But wait! Those are just the federal income tax benefits. Many individual states offer state tax benefits to people participating in 529 plans. As of this writing, 34 states and Washington D.C. offer these benefits. Of the 16 states not participating, nine of those don’t have any state income tax. The seven remaining states—California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina—all have state income taxes, yet do not offer income tax benefits to their 529 plan participants. Boo!

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This makes 529 plans an oddity. There’s a Federal-level tax advantage that applies to everyone. And then there might be a state-level tax advantage depending on which state you use to setup your plan.

Two Types of 529 Plans

The most common 529 plan is the college savings program. The less common 529 is the prepaid tuition program.

The savings program can be thought of as a parallel to common retirement investing accounts. A person can put money into their 529 plan today. They can invest that money in a few different ways (details further in the article). At a later date, they can then use the full value of their account at any eligible institution—in state or out of state. The value of their 529 plan will be dependent on their investing choices and how those investments perform.

The prepaid program is a little different. This plan is only offered by certain states (currently only 10 are accepting new applicants) and even by some individual colleges/universities. The prepaid program permits citizens to buy tuition credits at today’s tuition rates. Those credits can then be used in the future at in-state universities. However, using these credits outside of the state they were bought in can result in not getting full value.

You don’t choose investments in the prepaid program. You just buy credit’s today that can be redeemed in the future.

The savings program is universal, flexible, and grows based on your investments.

The prepaid program is not offered everywhere, works best at in-state universities, and grows based on how quickly tuition is changing (i.e. the difference between today’s tuition rate and the future tuition rate when you use the credit.)

Example: a prepaid credit would have cost ~$13,000 for one year of tuition in 2000. That credit would have been worth ~$24,000 of value if used in 2018. (Source)

What are “Qualified Education Expenses?”

You can only spend your 529 plan dollars on “qualified education expenses.” Turns out, just about anything associated with education costs can be paid for using 529 plan funds. Qualified education expenses include:

  • Tuition
  • Fees
  • Books
  • Supplies
  • Room and board (as long as the beneficiary attends school at least half-time). Off-campus housing is even covered, as long as it’s less than on-campus housing.

Student loans and student loan interest were added to this list in 2019, but there’s a lifetime limit of $10,000 per person.

How Do You “Invest” Your 529 Plan Funds?

529 savings plans do more than save. Their real power is as a college investment plan. So, how can you “invest” this tax-advantaged money?

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There’s a two-part answer to how your 529 plan funds are invested. The first part is that only savings plans can be invested, not prepaid plans. The second part is that it depends on what state you’re in.

For example, let’s look at my state: New York. It offers both age-based options and individual portfolios.

The age-based option places your 529 plan on one of three tracks: aggressive, moderate, or conservative. As your child ages, the portfolio will automatically re-balance based on the track you’ve chosen.

The aggressive option will hold more stocks for longer into your child’s life—higher risk, higher rewards. The conservative option will skew towards bonds and short-term reserves. In all cases, the goal is to provide some level of growth in early years, and some level of stability in later years.

The individual portfolios are similar to the age-based option, but do not automatically re-balance. There are aggressive and conservative and middle-ground choices. Thankfully, you can move funds from one portfolio to another up to twice per year. This allowed rebalancing is how you can achieve the correct risk posture.

Advantages & Disadvantages of Using a 529 Plan

The advantages of using the 529 as a college investing plan are clear. First, there’s the tax-advantaged nature of it, likely saving you tens of thousands of dollars. Another benefit is the aforementioned ease of investing using a low-maintenance, age-based investing accounts. Most states offer them.

Other advantages include the high maximum contribution limit (ranging by state, from a low of $235K to a high of $529K), the reasonable financial aid treatment, and, of course, the flexibility.

If your child doesn’t end up using their 529 plan, you can transfer it to another relative. If you don’t like your state’s 529 offering, you can open an account in a different state. You can even use your 529 plan to pay for primary education at a private school or a religious school.

But the 529 plan isn’t perfect. There are disadvantages too.

For example, the prepaid 529 plan involves a considerable up-front cost—in the realm of $100,000 over four years. That’s a lot of money. Also, your proactive saving today ends up affecting your child’s financial aid package in the future. It feels a bit like a punishment for being responsible. That ain’t right!

Of course, a 529 plan is not a normal investing account. If you don’t use the money for educational purposes, you will face a penalty. And if you want to hand-pick your 529 investments? Well, you can’t do that. Similar to many 401(k) programs, your state’s 529 program probably only offers a few different fund choices.

529 Plan FAQ

Here are some of the most common questions about 529 education savings plans. And I even provide answers!

How do I open a 529 plan?

Virtually all states now have online portals that allow you to open 529 plans from the comfort of your home. A few online forms and email messages is all it takes.

Can I contribute to someone else’s 529?

You sure can! If you have a niece or nephew or grandchild or simply a friend, you can make a third-party contribution to their 529 plan. You don’t have to be their parent, their relative, or the person who opened the account.

Investing in someone else’s knowledge is a terrific gift.

Does a 529 plan affect financial aid?

Short answer: yes, but it’s better than how many other assets affect financial aid.

Longer answer: yes, having a 529 plan will likely reduce the amount of financial aid a student receives. The first $10,000 in a 529 plan is not part of the Expected Family Contribution (EFC) equation. It’s not “counted against you.” After that $10,000, remaining 529 plan funds are counted in the EFC equation, but cap at 5.46% of the parental assets (many other assets are capped higher, e.g. at 20%).

Similarly, 529 plan distributions are not included in the “base year income” calculations in the FAFSA application. This is another benefit in terms of financial aid.

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Finally, 529 plan funds owned by non-parents (e.g. grandparents) are not part of the FAFSA EFC equation. This is great! The downside occurs when the non-parent actually withdraws the funds on behalf of the student. At that time, 50% of those funds count as “student income,” thus lowering the student’s eligibility for aid.

Are there contribution limits?

Kinda sorta. It’s a little complicated.

There is no official annual contribution limit into a 529 plan. But, you should know that 529 contributions are considered “completed gifts” in federal tax law, and that those gifts are capped at $15,000 per year in 2020 and 2021.

After $15,000 of contributions in one year, the remainder must be reported to the IRS against the taxpayer’s (not the student’s) lifetime estate and gift tax exemption.

Additionally, each state has the option of limiting the total 529 plan balances for a particular beneficiary. My state (NY) caps this limit at $520,000. That’s easily high enough to pay for 4 years of college at current prices.

Another state-based limit involves how much income tax savings a contributor can claim per year. In New York, for example, only the first $5,000 (or $10,000 if a married couple) are eligible for income tax savings.

Can I use my state’s 529 plan in another state? Do I need to create 529 plans in multiple states?

Yes, you can use your state’s 529 plan in another state. And mostly likely no, you do not need to create 529 plans in multiple states.

First, I recommend scrolling up to the savings program vs. prepaid program description. Savings programs are universal and transferrable. My 529 savings plan could pay for tuition in any other state, and even some other countries.

But prepaid tuition accounts typically have limitations in how they transfer. Prepaid accounts typically apply in full to in-state, state-sponsored schools. They might not apply in full to out-of-state and/or private schools.

What if my kid is Lebron James and doesn’t go to college? Can I get my money back?

It’s a great question. And the answer is yes, there are multiple ways to recoup your money if the beneficiary doesn’t end up using it for education savings.

First, you can avoid all penalties by changing the beneficiary of the funds. You can switch to another qualifying family member. Instead of paying for Lebron’s college, you can switch those funds to his siblings, to a future grandchild, or even to yourself (if you wanted to go back to school).

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What if you just want you money back? The contributions that you initially made come back to you tax-free and penalty-free. After all, you already paid taxes on those. Any earnings you’ve made on those contributions are subject to normal income tax, and then a 10% federal penalty tax.

The 10% penalty is waived in certain situations, such as the beneficiary receiving a tax-free scholarship or attending a U.S. military academy.

And remember those state income tax breaks we discussed earlier? Those tax breaks might get recaptured (oh no!) if you end up taking non-qualified distributions from your 529 plan.

Long story short: try to the keep the funds in a 529 plan, especially is someone in your family might benefit from them someday. Otherwise, you’ll pay some taxes and penalties.

Graduation

It’s time to don my robe and give a speech. Keep on learning, you readers, for:

An investment in knowledge pays the best interest

-Ben Franklin

Oh snap! Yes, that is how the blog got its name. Giving others the gift of education is a wonderful thing, and 529 plans are one way the U.S. government allows you to do so.

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

Source: bestinterest.blog

Will You Ever Be Able to Save Enough for Retirement?

retirement election year

With the stock market still in roller coaster mode and more and more companies reducing or eliminating retirement benefits, many people—from Boomers and Generation Xers to savvy Millennials—are facing the fact that they need to seize control of their retirement financial plan. And they need to do it sooner rather than later.

Boomers in particular are quickly realizing that the landscape for long-term savings has changed dramatically since they signed up for their 401(k)s in the 1970s, 1980s or 1990s.

Planning wasn’t as crucial back then, said David Krasnow, 44, President/CEO of Pension Advisors in Cleveland. ”Between pension plans, 401(k)s, and home equity, it was assumed that the continual growth of investments and home value together with Social Security would provide plenty of money when employees stopped working,” he said. With a formula that basic, professional planners didn’t need deep investment expertise to deliver solid results.

“There were few certifications or fee disclosure requirements,” Krasnow pointed out. “The same person who sold you health insurance might sell you an investment program.”

That laissez-faire approach might have worked for people who worked, uninterrupted, until 65 (not facing protracted periods of unemployment) and not as contractors and/or part-timers or small-business owners.  It worked when the stock market produced steady 8% gains per year, not tumultuous volatility. It worked when companies offered generous 401(k) matches—and stayed out of bankruptcy to actually fund pensions. And it worked when home property values were growing—or at least stable.

But it doesn’t work now, and this is why:

  • We can’t assume continual growth of investments or home equity. Nor can we count on Social Security to be solvent 30-40 years from now.  That’s the new economic normal.
  • We’re anticipating living longer, staying active longer (which influences spending and other financial considerations), and with advancing age, facing the likelihood of considerable medical-related expenses.
  • Our parents are living longer.  Boomers looking to retire may want to help fund their parents’ later years as well as their own. And, of course, there’s the question of children and grandchildren, and whether (and how much) to spend on them when you don’t have a full income.
  • Traditional pensions or other employee-sponsored retirement plans may not be sufficient sources of retirement funds.
  • Investment products are more plentiful and more complex (read: confusing) than ever.
  • Retirees often continue working long past their 60s, which affects traditional assumptions about how much savings is needed when they do stop working.

So what does all of this mean for anyone intent on building a solid retirement financial plan?

1. Recognize the Need for a Professional Adviser

“In a constantly improving market I used to be able to manage my mutual fund investments on my own,” said Peter Doris, 66, a career and nonprofit expert from Philadelphia.  “Now I need a professional’s help. It isn’t just a question of putting money aside.  It’s a question of being really smart and current about each investment, and I simply don’t have the time or the background.”

2. Do Your Homework

“There is a minimum set of skills and knowledge base you must have, even if you use a professional,” said Jim McGrath, an Executive Vice President of Law and Administration, 67, in Orland Park, Ill. “Take seminars, do online research and read up so that you have solid financial literacy,” he suggests.  “You can’t make informed decisions without fully understanding your choices, their projected outcomes and their potential risks.”

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3. Be on the Same Page With Your Significant Other

If you’re married or in a relationship, make sure both spouses/partners are in agreement about life planning, investment objectives, reasonable returns and levels of acceptable risk. “My wife and I built our business together,” said Ted Vlamis, 78, an active CEO in Wichita. “She knows the numbers, so there are no surprises. We know that the chances are good that one partner will outlive the other, and any survivor shouldn’t be blindsided by financial problems they knew nothing about … or have to face, unprepared and grieving, the host of decisions that have to be made about a business or an investment portfolio.”

4. Own It

Dr. Deborah Ewing-Wilson, 58, a neurologist in a large Ohio medical system, advises people to “give the same due diligence to their personal and financial lives that they give to their work and businesses.”  It’s time-consuming and sometimes tedious, she admits, but then again so is taking care of one’s health.  “I’m here to help educate, recommend, and advise, but I can’t take responsibility for anyone else’s behavior or decisions,” she says. “It’s the same with a financial plan.”  In other words, it’s your money, your plan, your life.

5. Start Now

“Find a professional you trust, start saving as soon as you can, and stay on top of your plan, ready to make decisions as markets–and your life—evolve,” says Rich Iafellice, 57, vice president of an engineering services firm near Akron. He suggests working with an adviser who works on a fee basis, not on a percentage of growth of your portfolio.  “That way they’re focused solely on your needs and risk tolerance, not the potential for them to make big profits off of a portfolio that might be too ambitious for your comfort.”

Two last caveats: When shopping for an investment adviser, look for the designations CFP (certified financial planner), PFS (personal financial specialist) and CFA (chartered financial analyst). Anyone with these credentials has to have completed training from an accredited body, and passed rigorous exams demonstrating their competence. Certification is only one indicator of ability, however. The real test is whether an adviser has been successful for an extended period of time and is recommended by people you trust and respect.

More Money-Saving Reads:

  • What’s a Good Credit Score?
  • How to Get Your Free Annual Credit Report
  • What’s a Bad Credit Score?
  • How Credit Impacts Your Day-to-Day Life

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The post Will You Ever Be Able to Save Enough for Retirement? appeared first on Credit.com.

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What Long-Term Care Insurance Covers

what does long term care insurance cover
While Medicare and Medicaid both help aging adults afford some of their medical expenses, they may not cover the cost of an extended illness or disability. That’s where long-term care insurance comes into play. Long-term care insurance helps policyholders pay for their long-term care needs such as nursing home care. We’ll explain what long-term care insurance covers and whether or not such coverage is something you or your loved ones should consider.

Long-Term Care Insurance Explained

Long-term care insurance helps individuals pay for a variety of services. Most of these services do not include medical care. Coverage may include the cost of staying in a nursing home or assisted living facility, adult day care or in-home care. This includes nursing care, physical, occupational or speech therapy and help with day to day activities.

A long-term care insurance policy pays for the cost of care due to a chronic illness, a disability, or injury. It also provides an individual with the assistance they may require as a result of the general effects of aging. Primarily, though, long-term care insurance is designed to help pay for the costs of custodial and personal care, versus strictly medical care.

When You Should Consider Long-Term Care Insurance

During the financial planning process, it’s important to consider long-term care costs. This is important if you are close to retirement age. Unfortunately, if you wait too long to purchase coverage, it may be too late. Many applicants may not qualify if they already have a chronic illness or disability.

According to the U.S. Department of Health and Human Services, an adult turning 65 has a 70% chance of needing some form of long-term care. While only one-third of retirees may never need long-term care coverage, 20% may need it for five years or longer. With a private nursing home room averaging about $7,698 per month, long-term care could end up being a huge financial burden for you and your family.

Most health insurance policies won’t cover long-term care costs. Additionally, if you’re counting on Medicare to assist you with these extra expenses, you may be out of luck. Medicare doesn’t cover long-term care or custodial care. Most nursing homes classify under the custodial care category. This classification of care includes the supervision of your daily tasks.

So, if you don’t have long-term care insurance, you’re on the hook for these expenses. However, it’s possible to get help through Medicaid for low income families. But keep in mind, you may only receive coverage after you deplete your life savings. Just know that Medicare may cover short-term nursing care or hospice care, but little of the long-term care in between.

What Does Long Term Care Insurance Cover

what does long term care insurance coverSo what does long term care insurance cover, Well, since the majority of long-term care policies are comprehensive policies, they may cover at-home care, adult day care, assisted living facilities (resident care or alternative care), and nursing home care. At home, long-term care may cover the cost of professional nursing care, occupational therapy, or rehabilitation. This may also include assistance with daily tasks, including bathing or brushing teeth.

Additionally, long-term care coverage can cover short-term hospice care for individuals who are terminally ill. The objective of hospice care is to help with pain management and provide emotional and physical support for all parties involved. Most policies allow beneficiaries to obtain care at a hospice facility, nursing home, or in the comfort of their own home. However, most hospice care is not considered long-term care and may receive coverage through Medicare.

Also, long-term care insurance can help cover the costs of respite care or temporary care. These policy extensions provide time off to those who care for an individual on a regular basis. Usually, respite care provides compensation to caregivers for 14 to 21 days a year. This care can take place at a nursing home, adult daytime care facility, or at home

What Long-Term Care Doesn’t Cover

If you have a pre-existing medical condition, you may not be eligible for long-term care during the exclusion period. The exclusion period can last for several months after your initial purchase of the policy. Also, if a family member provides in-home care, your policy may not pay them for their services.

Keep in mind, long-term care coverage won’t cover medical care costs. Many of your medical costs will fall under your coverage plan if you’re eligible for Medicare.

Long-Term Care Insurance Costs

Some of the following factors may affect the cost of your long-term care policy:

  • The age of the policyholder.
  • The maximum amount the policy will pay per year.
  • The maximum number of days the policy will pay.
  • The lifetime maximum amount that the policy will pay
  • Any additional options or benefits you choose.

If you’re in poor health or you’re currently receiving long-term care, you may not qualify for a plan. However, it’s possible to qualify for a limited amount of coverage with a higher premium rate. Some group policies don’t even require underwriting.

According to the American Association for Long-Term Care Insurance (AALTCI), a couple in their mid-50s can purchase a new long-term care policy for around $3,000 a year. The combined benefit of this plan would be roughly $770,000. Keep in mind, some policies limit your payout period. These payout limitations may be two to five years, while other policies may offer a lifetime benefit. This is an important consideration when finding the right policy.

Bottom Line

what does long term care insurance coverWhile it’s highly likely that you may need some form of long-term care, it’s wise to consider how you will pay for this additional cost as you age. While a long-term care policy is a viable option, there are alternatives you can consider.

One viable choice would be to boost your retirement savings to help compensate for long-term care costs. Ultimately, it comes down to what level of risk you’re comfortable with and how well a long-term care policy fits into your bigger financial picture.

Retirement Tips

  • If you’re unsure what long-term care might mean to your retirement plans, consider consulting a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • The looming costs of long-term care may have you thinking about how much money you’ll need for retirement. If you aren’t sure how much your 401(k) or Social Security will factor into the equation, SmartAsset’s retirement guide can help you sort out the details.

Photo credit: ©iStock.com/KatarzynaBialasiewicz, ©iStock.com/scyther5, ©iStock.com/PeopleImages

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401k Early Withdrawal: What to Know Before You Cash Out

When it comes to making a 401k early withdrawal, there are a number of reasons why it might be tempting. With millions still unemployed due to the pandemic, unexpected expenses are taking a particularly hard toll. One reason why early withdrawal isn’t uncommon in the U.S. might be because it’s easy to assume you’ll have time to rebuild your 401k nest egg.

However, is the benefit of withdrawing your retirement savings early truly worth the cost? For many people, their 401k is their primary method of investing in their financial future. Before making a decision about early withdrawal, it’s important to consider the penalties and fees that could impact you. Read on to learn exactly what happens when you decide to dip into your 401k so you won’t be surprised by the repercussions.

How Much Are You Penalized for a 401k Early Withdrawal?

On the surface, withdrawing funds from your 401k might not seem like a bad option under extenuating circumstances, but you could face penalties. Young adults are especially prone to early withdrawals because they figure they have plenty of time to replace lost funds.

 

401k early withdrawal penalties

 

If you’re not experiencing a significant hardship, 401k early withdrawal probably isn’t the right choice for you. Ultimately, you could lose a substantial portion of your retirement savings if you choose to withdraw your 401k early to use the money to make other risky financial moves. Below, let’s delve further into the penalties that usually apply when you withdraw early.

1) Your Taxes Are Withheld

When you prematurely withdraw from your retirement account, your first consideration should be that you’ll have to pay normal income taxes on that money first. This means you’re losing at least roughly 30 percent of your savings to federal and state taxes before additional penalties.

Even if you only have $10,000 you want to withdraw, consider that you’re automatically giving $3,000 of your cash to the government. In the best case scenario, you might receive some money back in the form of a tax refund if your withholding exceeds your actual tax liability.

2) You Are Penalized by the IRS

If you withdraw money from your 401k before you’re 59 ½ , the IRS penalizes you with an extra 10 percent on those funds when you file your tax return. If we use the example above, an additional $1,000 would be taken by the government from your $10,000 — leaving you with just $6,000. If you’re 55 or older, you could try to get this penalty lifted by the IRS through the Rule of 55, which is designed for people retiring early.

Also, there are exceptions under the CARES Act, which is designed to help people affected by the pandemic. There are provisions under the act that state individuals under the age of 59 ½ can take up to $100,000 in Coronavirus-related early distributions from their retirement plans without facing the 10 percent early withdrawal penalty under certain conditions.

3) You Lose Thousands in Potential Growth

Even if you’re not deterred by tax penalties, think twice before you sabotage your long-term retirement savings goals. When you withdraw money early, you’ll miss out on potential future savings growth because you won’t gain the perks of compound interest. Compounding is the snowball effect resulting from your savings generating more earnings — not only on your principal investment but also on your accrued interest.

Also, if you make a 401k early withdrawal while the market is down, you’re doing yourself a disservice because you’ll be leaving thousands on the table. It’s unlikely you’ll fully recover the lost years of compound interest you would have benefited from. You might need to get creative with a passive income stream to help support you later in life.

 

tips to minimize 401k withdrawal penalties

 

When Does a 401k Early Withdrawal Make Sense?

In certain cases, it actually might be strategic to move forward with 401k early withdrawal. For example, it could be smart to cash out some of your 401k to pay off a loan with a high-interest rate, like 18–20 percent. You might be better off using alternative methods to pay off debt such as acquiring a 401k loan rather than actually withdrawing the money.

Always weigh the cost of interest against tax penalties before making your decision. Some 401k plans do allow for penalty-free early withdrawals due to a layoff, major medical expenses, home-related costs, college tuition, and more. Regardless of your strategy to withdraw with the least penalties, your retirement savings are still taking a significant hit.

401k Early Withdrawal, Hardship, or Loan: What’s the Difference?

Knowing the differences between a 401k early withdrawal, a hardship withdrawal, and a 401k loan is crucial. Due to the many obstacles to make a 401k early withdrawal, you may find you want to keep it untouched. If you’re convinced you still need to use your 401k for financial assistance, consult with a trusted financial advisor to figure out the best option.

When Does This Apply?

Taxes and
Penalties

Early Withdrawal

Your funds are withdrawn to pay off large debts or finance large projects. Your 401k fund is typically subject to taxes and penalties.

Hardship Withdrawal

You’re only eligible for this type of withdrawal under circumstances such as a pandemic or natural disasters. Withdrawals can’t exceed the amount of the need and the funds are still subject to taxes and penalties.

401k Loan

The loan must be paid back to the borrower’s retirement account under the plan. The money isn’t taxed if the loan meets the rules and the repayment schedule is followed.

Additional Considerations

If you’ve left a job and don’t know what to do with your Roth IRA, a 401k transfer is a good option. Most likely, you will save money and have a wider range of investment options when you transfer your funds. 401k fees can be high, and rolling over your funds to a Roth IRA account could be wise in the long run. Also, be aware that the process is more complicated for indirect rollovers. 

In Summary:

  • If you’re one of the millions of Americans who rely on workplace retirement savings, early 401k withdrawal may jeopardize your future financial stability.
  • There are very few instances when cashing out a portion of your 401k is a smart move.
  • In most cases, any kind of early 401k withdrawal is detrimental to your retirement plans.
  • Stick to your budget and bulk up your emergency fund to stay one step ahead.

In short, 401k early withdrawals are usually counterproductive. Prevent compromising your hard-earned savings by using a free budgeting tool that will set you up for success. After all, being prepared and informed are two of the most important parts of maintaining financial health.

Source: SEC

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