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Save and Save


 

Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in a bank or pension plan.[1] Saving also includes reducing expenditures, such as recurring costs. In terms of personal finance, saving specifies low-risk preservation of money, as in a deposit account, versus investment, wherein risk is higher. There is some disagreement about what counts as saving. For example, the part of a person's income that is spent on mortgage loan repayments is not spent on present consumption and is therefore saving by the above definition, even though people do not always think of repaying a loan as saving. However, in the U.S. measurement of the numbers behind its gross national product (i.e., the National Income and Product Accounts), personal interest payments are not treated as "saving" unless the institutions and people who receive them save them.


 

"Saving" differs from "savings." The former refers to an increase in one's assets, an increase in net worth, whereas the latter refers to one part of one's assets, usually deposits in savings accounts, or to all of one's assets. Saving refers to an activity occurring over time, a flow variable, whereas savings refers to something that exists at any one time, a stock variable.


401(k)

 

In the United States, a 401(k) or 401k retirement savings plan allows a worker to save for retirement, and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. This type of plan is also known as a "traditional" 401(k). 401(k) plans are mainly employer-sponsored: employees elect to have a portion of their wages paid directly into their individual 401(k) account, which is managed by the employer. Such payments are known as "contributions". Since 2006, another type of 401(k) plan is available. Participants in 401(k) plans that have the proper amendments can allocate some or all of their contributions to a separately-designated Roth account, commonly known as a Roth 401(k). These "Roth" contributions will be collected and treated as after-tax dollars; that is, income tax is paid or withheld in the year contributed. Qualified distributions from a designated Roth 401(k) account, including all income, are tax-free. (A traditional 401(k) account is funded with pre-tax dollars and, in general, tax must be paid when the original contribution and earnings are withdrawn.)


 


 

As a benefit to the employee, the employer can optionally choose to "match" part or sometimes all of the employee's contribution by depositing additional amounts in the employee's 401(k) account or simply offering a profit-sharing contribution to the plan. All employer matching funds are deposited into the account on a pretax basis, even if the employee's contributions are all Roth contributions. Employer contributions may be subject to vesting rules set by the plan documents requiring the employee to reach a certain number of years of service before they are entitled to keep the matching funds.


IRA: Roth vs. Traditional

 

The decision between choosing a Roth IRA vs. a Traditional IRA depends mostly on whether you are likely to be in a higher tax bracket in the future (in which case a Roth IRA is better) or a lower tax bracket in the future (in which case a conventional IRA is better). Roth IRAs also have a bit more flexibility in terms of early withdrawal. If your tax bracket does not change while you are working vs. when you retire, you will end up with the same amount of money in a Roth IRA as a conventional IRA for a donation less than the maximum allowable. If you save the maximum allowable amount in an IRA, and you stay in the same tax bracket, there is a tax advantage to the Roth-IRA. For instance, in 2010 the maximum traditional IRA for a 40 year old was $5000. Any additional investment above that would have to go into a different account.


 

Retirement was simpler when all you had to do was put in your time at work, retire and collect your checks. Between the company pension and Social Security, most retirees figured they had it made. And if they'd managed to save a little extra, it was gravy. These days, that's all changed. For most workers, traditional defined-benefit pension plans have become a thing of the past. And few people seriously expect Social Security to provide the majority of what they hope to spend in retirement.


IRAs and 401(k)s

 

Your main workhorses for retirement savings will likely be an IRA along with a 401(k), 403(b), 457 or other qualified employer plan, depending on what your workplace offers. If you have earned income but your employer doesn't offer a retirement plan, you can always start by putting money in a traditional IRA or Roth IRA. But if you also have access to a 401(k) or other employer plan, should you fund your 401(k), your IRA or both?


 

If your 401(k) offers a matching contribution, that's usually the best place to start. For example, let's say you make $50,000. Your employer matches your 401(k) contributions dollar-for-dollar up to 6% of your salary, which for you amounts to $3,000. In this case, the first $3,000 of savings should go into your 401(k) plan. Why give up free money?


If you're eligible to make a deductible contribution to a traditional IRA

 

your next $5,000 there—especially if you expect to be in the same or lower income tax bracket in retirement when you take withdrawals. You're still getting a pretax deduction as you do with your 401(k), but you'll likely have more investment choices. If you can afford to save more after contributing $5,000 to a traditional IRA ($6,000 if you’re 50 or older in 2010), then continue with your 401(k) up to the maximum allowed.


If you're not eligible to make a deductible contribution to a traditional IRA but you're eligible for a Roth IRA

 

consider putting your next $5,000 into a Roth ($6,000 if you’re 50 or older in 2010). Your contribution won't be deductible, but qualified withdrawals will be tax free down the road. If you're in a higher tax bracket when you make your withdrawals, the Roth would be especially attractive. Ending up in the same bracket would mean a wash for income tax purposes—but a Roth IRA has other advantages. A Roth IRA doesn't force you to take required minimum distributions at age 70½, as you'd have to do with a qualified employer plan or traditional IRA. That's an advantage in terms of letting your Roth IRA continue to grow tax deferred in your later years. It could also benefit your heirs, who'd be able take money out income tax free after you're gone. Again, if you're able to save more after you put $5,000 in a Roth, continue with your 401(k) until you max it out.


If you're eligible for neither a deductible contribution to a traditional IRA nor a Roth IRA contribution

 

then just continue with your 401(k) until you've contributed the maximum allowed.


What if I've maxed out my 401(k) and IRA?

 

If you've maxed out your 401(k) and whatever IRA option makes the most sense, and you're looking to save more, kudos are in order! Here's where to go with those extra retirement dollars:


 


Regular brokerage account

 

Additional retirement savings can go right into your brokerage account. Remember, even if you hold retirement assets in both taxable and tax-advantaged accounts, you should consider all your investments as one big portfolio reflecting a single asset allocation. What's more, you may be able to add value by placing more tax-efficient investments in your taxable accounts and less tax-efficient investments in your tax-advantaged accounts.


Nondeductible contribution to a traditional IRA

 

Even if you're covered by an employer plan and you're above the AGI limit for a Roth IRA or a deductible contribution to a traditional IRA, you can still make a nondeductible contribution to a traditional IRA. Whether you should or not is a tough call. Besides no up-front deduction, any earnings will be taxed as ordinary income when you withdraw them, so a nondeductible IRA contribution isn't an overly compelling choice. The advantage rests solely on the benefit of tax-deferred compounding. But you could effectively defer taxes on stocks in your taxable accounts by trading infrequently or buying an index fund. And if you're in a higher tax bracket and you want to hold bonds in your taxable account, you could always buy municipal bonds, which are tax free.


Deferred variable annuities

 

This option has some similarities to a nondeductible IRA contribution, with some notable differences: Most deferred variable annuities have an optional death benefit, so your heirs would at least be sure to get what you put in, even if your investments lose value. There are no required minimum distributions to deal with. You have the option to annuitize your balance, which might come in handy if you're looking for a regular monthly check at some point during retirement. The downside here is that variable annuities typically include additional costs and fees that can make them relatively expensive.


The bottom line

 

If you haven't begun to save for retirement—or you're saving less than you should—what are you waiting for? Now that you know which retirement accounts make the most sense, start filling them up!


401k Loans and 401k Hardship Withdrawals

 

The purpose of your 401k retirement plan is to provide for your golden years. There are times, however, when you need cash and there are no viable options other than to tap your nest egg. For this reason, the government allows plan administrators to offer 401k loans to participants (be aware that the government doesn’t require this and therefore it is not always available.


 

The primary benefit of 401k loans is that the proceeds are not subject to taxes or the ten-percent penalty fee except in the event of default. The government does not set guidelines or restrictions on the uses for 401k loans. Many employers, however, do; these can include minimum loan balances (usually $1,000) and the number of loans outstanding at any time in order to reduce administrative costs. Additionally, some employers require that married employees get the consent of their spouse before taking out a loan, the theory being that both are affected by the decision.


 


401k Loan Limits

 

In most cases, an employee can borrow up to fifty-percent of their vested account balance up to a maximum of $50,000. If the employee has taken out a 401k loan in the previous twelve months, they will only be able to borrow fifty-percent of their vested account balance up to $50,000, less the outstanding balance on the previous loan. The 401k loan must be paid back over the subsequent five years with the exception of home purchases, which are eligible for a longer time horizon.


401k Loan Interest Expense

 

Even though you’re borrowing from yourself, you still have to pay interest! Most plans set the standard interest rate at prime plus an additional one or two percent. The benefit is two-fold: 1.) unlike interest paid to a bank, you will eventually get this money back in the form of qualified disbursements at or near retirement, and 2.) the interest you pay back into your 401k plan is tax-sheltered.


The Drawbacks of 401k Loans

 

The biggest danger of taking out a 401k loan is that it will disrupt the dollar cost averaging process. This has the potential to significantly lower long-term results. Another consideration is employment stability; if an employee quits or is terminated, the 401k loan must be repaid in full, normally within sixty days. Should the plan participant fail to meet the deadline, a default would be declared and penalty-fees and taxes assessed.


401k Hardship Withdrawal

 

What if your employer doesn’t offer 401k loans or you are not eligible? It may still be possible for you to access cash if the following four conditions are met (note that the government does not require employers to provide 401k hardship withdrawals, so you must check with your plan administrator): 1.The withdrawal is necessary due to an immediate and severe financial need 2.The withdrawal is necessary to satisfy that need (i.e., you can’t get the money elsewhere) 3.The amount of the loan does not exceed the amount of the need 4.You have already obtained all distributable or non-taxable loans available under your 401k plan If these conditions are met, the funds can be withdrawn and used for one of the following five purposes:


 

1.A primary home purchase 2.Higher education tuition, room and board and fees for the next twelve months for you, your spouse, your dependents or children (even if they are no longer dependent upon you) 3.To prevent eviction from your home or foreclosure on your primary residence 4.Severe financial hardship 5.Tax-deductible medical expenses that are not reimbursed for you, your spouse or your dependents


 

All 401k hardship withdrawals are subject to taxes and the ten-percent penalty. This means that a $10,000 withdrawal can result in not only significantly less cash in your pocket (possibly as little as $6,500 or $7,500), but causes you to forgo forever the tax-deferred growth that could have been generated by those assets. 401k hardship withdrawal proceeds cannot be returned to the account once the disbursement has been made.


Non-Financial Hardship 401k Withdrawal

 

Although the investor must still pay taxes on non-financial hardship withdrawals, the ten-percent penalty fee is waived. There are five ways to qualify: 1.You become totally and permanently disabled 2.Your medical debts exceed 7.5 percent of your adjusted gross income 3.A court of law has ordered you to give the funds to your divorced spouse, a child, or a dependent 4.You are permanently laid off, terminated, quit, or retire early in the same year you turn 55 or later 5.You are permanently laid off, terminated, quit, or retired and have established a payment schedule of regular withdrawals in equal amounts of the rest of your expected natural life. Once the first withdrawal has been made, the investor is required to continue taking them for five years or until he/she reaches the age of 59 1/2, whichever is longer.