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Retirement Investing - Borrowing From Your 401k - Part 1

October 31st, 2006 by Papabear

For most people saving for retirement, our retirement savings account, whether it’s in a 401k account or an Individual Retirement Account or IRA, is our biggest or second biggest asset, next to our home. And unlike the equity in our home, the money in our 401k account or IRA is exactly that – our money. Liquid Assets. It’s tangible and does not go up and down with the value of the real estate market.

Most of us have our 401k account or IRA in a plan that allows us to borrow a portion of the money. This can be a great idea and a ready source of money, but there are positives and negatives to borrowing from your retirement savings account. Here’s a list of 8 things to consider before taking out a loan from your retirement account. Since the list is long, I’ll post it over 4 days. Let’s start with 4 good reasons:

1. Most plans allow you to borrow up to 50% of the vested balance in your account, up to $50,000.

2. Interest rates are usually competitive and are often lower than your could get from a bank on a signature loan. Borrowing your own money is not technically a signature loan, because you are pledging the money in the account to back up the loan, but because it’s so quick and simple, it’s more like getting a signature loan on a note at the bank than the longer process of pledging assets for a loan guarantee.

3. Because your are borrowing your own money, you don’t have to “qualify” for a loan, like you would for a signature or other loan from a bank, so you don’t have to worry about your credit rating.

4. Since you’re borrowing your own money, the interest you pay on the loan goes back into your own pocket and not the banker’s, since it goes into your account. If your 401k account is primarily invested in your company stock or even in a mutual fund that has a low or falling rate of return at the moment, you might actually earn more money from the interest you pay on your loan, even if it’s only 5 or 6%.

So – 4 good reasons to consider borrowing from your retirement account when you need some extra money. Tomorrow, we’ll look at 2 reasons you might want to reconsider.

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    Retirement Investing - The Starbucks Investing Plan

    October 22nd, 2006 by Papabear

    No - this is not a post about investing in Starbucks. If you or I had done that 10 years ago, we would already be retired by now. This is a little more practical.

    Many articles on retirement planning and investing for retirement focus on what is the best investment if you have an extra $10,000 or $100,000 lying around. That’s a good thing to know if you really have an extra $10,000 or $100,000. But what about the rest of us?

    Sometimes simple changes in our habits can make a tremendous difference in our future. We all know we need to save for the future - and to save on a consistent basis. That’s the cornerstone of retirement planning. But where do we find the money for investments or retirement planning?

    Let me show you something that hopefully inspires you to get started investing if you haven’t already. Starbucks charges about $3.75 plus tax for a mocha latte frappachino.

    A visit to Starbucks, often daily, has become a habit for many of us. But what would happen if you used that $3.75 a day for retirement planning?

    If you begin when you’re 25 and saved $3.75 a day, 5 days a week, that’s about $81.25 you’d have to invest in an Individual Retirement Account (IRA) or other tax deferred account every month. If you earned 8% interest in your IRA, you would have over $285,000 at Age 65.

    If you’re already past Age 25, the same principle still applies. There will just be less time to invest and less time for the miracle of compound interest to multiply your money. If you began at Age 35, you would have $187,000 at age 65. Even if you began at Age 45, you would still have nearly $78,000 in your Individual Retirement Account or IRA at Age 65.

    This post is not a criticism of Starbucks. They make great coffee. If you don’t buy it there, you can always make it at home or the office for less than 15 cents a cup. You don’t have to give up coffee to begin saving for retirement. The point is that saving even a small amount of money on a consistent basis can pay huge dividends in the future.

    Retirement investing requires some discipline, and yes, maybe a little sacrifice. If it’s not Starbucks, find some other expense you can cut back on, and begin your retirement planning by making regular contributions into your IRA or 401(k) plan today.

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    Retirement Investing - What Would Jesus Do?

    October 20th, 2006 by Papabear

    This blog seems to have taken off in a direction of its own. It wasn’t my original plan to devote so much space only to how-to financial issues. I meant to write a post on the subject of retirement planning and the steps for determining how much you need to save in your retirement savings account to fund the retirement lifestyle you want. When I typed up that little piece of advice, even covering the steps briefly, I realized it had grown into over 1,500 words of advice. Because it got so long, I divided it into 3 parts.

    So before this blog begins to sound like a dry financial planning textbook, let’s talk about some related things. What about retirement planning and planning for the future in general?

    In the Sermon on the Mount in the Kings James version so many of us are familiar with, Jesus says:

    “Take therefore no thought for the morrow: for the morrow shall take thought for the things of itself.” (Matt. 6:25)

    When most of us hear these words, we understand them to mean Jesus was saying you don’t have to plan ahead. I even heard a man once who was bragging that he didn’t have any life insurance, and he justified it based on this Bible verse. That might be fine for him. He wouldn’t be around to suffer the consequences, but what about his survivors?

    I got out my copy of Dale Carnegie’s great book “How to Stop Worrying and Start Living” because I remembered he discussed this. Dale Carnegie says that when the KJV was written 400 years ago, “thought” frequently meant “anxiety”. So the verse is really better translated “have no anxiety for tomorrow” or “don’t worry about tomorrow”.

    The New International Version puts it this way in :

    “Therefore I tell you, do not worry about your life…Can any one of you by worrying add a single hour to your life?” Matt. 6:25-27

    What does this mean for retirement planning? Dale Carnegie says, by all means yes, you should think about tomorrow and do some careful planning and preparation. What Jesus was saying was - don’t spend your time worrying about tomorrow.

    Planning is productive, both retirement planning and other planning for the future. Worrying is not. That was great advice 2,000 years ago. It’s still great advice today.

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    Retirement Investing - How Much Should You Save? - Part 1

    October 17th, 2006 by Papabear

    Retirement age is often called “The Golden Years”. One thing is certain. Retirement will be a lot more fun if you have enough gold to enjoy it. What follows is a summary of what I’ve learned from reading a number of books on retirement planning and setting up retirement accounts. To make it more readable, I’ve broken into 3 parts. Here’s Part 1.

    In these steps, I’ve kept the math in the example simple to make the process easy to follow. Some folks have written entire books on this subject, and they make excellent reading when you’re ready to get into the process in detail. First step through the process in this simple example and then go into greater detail by doing a little research on your own when you are ready to set up your own retirement savings plan. The important point is - don’t delay getting started until you understand every complex twist and turn of the tax laws and all the investment options. That’s what the pro’s are for. Begin by understanding the basics and then get started. As a friend of mine says about any worthwhile project “It’s more important to get it going than to get it perfect”. So in the famous words of Nike - “just do it”.

    Step 1 - Determine how much income you will need to have a comfortable retirement lifestyle. The old rule of thumb many investment advisors recommended was 80% of your current income. However, that’s a very general guideline. You really need to examine your own situation for a better number. Is your home paid for, or will it be paid for when you retire? Then you won’t need money to cover a mortgage payment. If you and your spouse are driving 2 cars now, will you cut back to one car? That’s one less car to maintain or eventually replace. If you currently live in a large house, will you be moving to a smaller house? That’s less for utilities, and the proceeds from the sale of the larger house can go into your retirement account. You’ll also have to factor in that you will have new expenses you didn’t have before. You may need to buy more medicines as you get older. If you have a health plan from your current employer, your share of the cost may go up. You will also probably want to buy Medicare insurance to cover your share of medical costs not covered by Medicare.

    Step 2 - Determine what rate of return you believe you can get on your retirement savings. There are many references out there on what rate of return to use for retirement planning. Let’s try to keep the math simple. According to a research report prepared for the Social Security Advisory Board in 2001, the average real rate of return for stocks from 1946 to 1998 was 7.8% after inflation. That seems like a good time period to use because it avoids the Internet boom and bust between 1998 and 2002. This is 7.8% in real, not inflated dollars.

    Of course, 7.8% is truly an average over time. In some years the stock market has done very well. In other years, it has taken a big slide. It can be very hard to predict a rate of return over a short period of time. So for the sake of simplicity, let’s round the 7.8% up to 8%. For your own planning, if you want to be more conservative, you can always use an even lower rate.

    Tomorrow in Part 2, we’ll walk through some simple calculation to determine how much you need to save to provide the monthly income you need.

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