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A 401(k) "Margin Call"

Question: My former employer has gone into receivership and I was informed that they will be terminating their 401k program. I would have rolled my 401k over into an IRA a year ago had it not been for a personal loan I took out against it. The outstanding balance is about $9,000.00, or about 35% of the value of the account. (A side note, last year, the loan was, in fact, outperforming most of the other elements of the plan!)

According to the letter I received from the financial services group involved, my options are:
1) Pay off the loan, which is possible, if I tap my home equity, and roll the whole thing into an IRA. or ...
2) Deduct the outstanding balance from the 401k, roll over the un-leveraged balance into an IRA, and pay taxes on the loan amount.

I do have an open line of credit with my bank against my house, with a zero balance, that I could use to avoid the tax consequences.

What would you do? It kind of feels like a margin call, and right now, I could ring my former employer's neck.

Thanks!

Answer: I don't blame you for being upset. You did get the equivalent of a "margin call." You borrowed money to invest, and now the bill is coming due quickly. By the way, I have to say that I am not a fan of borrowing money to invest. I think leveraging up a portfolio like that is too risky for most people. What's more, although I hear the "mantra" that when you borrow from your 401(k) you're borrowing from yourself, I don't find the idea persuasive. It's still an expensive loan.

That said, what do I think is your best option? I would choose to pay off the loan by borrowing on the home equity line of credit--with this critical caveat: That you can repay the loan quickly. If the answer to that is "yes," it'll allow you to roll the whole amount in your 401(k) into an IRA and avoid an income tax hit, as well as the 10% penalty to Uncle Sam.

03/05/08 by Chris Farrell

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Market Turmoil and a Retirement Portfolio

Question: My husband and I both put the maximum into our 401ks, which we now see dwindling (9% loss this year already). Money is tight; our daughter is making the decision about what college to attend; and we do not have a lot in savings ($200k in our 401ks; $50k in stocks). Should we continue to put the max into our 401ks or decrease the contribution during this economic downturn? We both turn 50 this year. Thank you so much for your help. Kary.

Answer: With the drop in the market, I'm getting many variations of your question. The feeling about retreating from the market is understandable. But here's my cautionary note: You're both still young. Taking into account your average life expectancy, you're still investing for another 30-plus years. That's why the main lesson I would take from this volatility and turmoil in the market is to review your portfolio. Are you comfortable with how much you have in stocks, bonds, and other securities? Do you need to get more conservative?

That said, you have a big expense coming up: Your daughter's college education. It's a big deal, and if you want to slightly cut your contributions to your retirement savings in order to help pay for college expenses, that's fine (with me, that is).

Nevertheless, I do believe you should take care of your retirement needs first and your daughter's college expenses second. She can always borrow. The reason for establishing this priority is that you and your husband are nearing the end of your earnings years to save for retirement, and she has a lifetime ahead of her.

03/12/08 by Chris Farrell

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Market Turmoil

Question: I have some money in 401K but it's all vanishing because of the stock market drop. Is it a good idea to ride it out,or transfer the money out of stocks (investment optons) and put it in a safe stable fund? Frank, Satellite Beach, FL

Answer: A bear is mauling the stock market, and the worst may be yet to come. The S&P 500 is down some 17% from its October high, still in so-called correction territory but not all that distant from the 20% decline that traditionally defines a bear market. The desire to get away from the carnage is understandable. (My answer to your question assumes that you're still in the "accumulation" stage of life, working and adding to your retirement portfolio.)

Still, for many investors the first rule of managing money in a downturn seems to be "do no harm." When people try to time the market, the result is usually disastrous. The average saver who sits tight with their retirement money during a bear market typically does much better than the person that gets in and out of the market.

That said, my mantra is to take advantage of this time by figuring out whether you're comfortable with your portfolio. Are you too much in stocks? Bonds? International? How do you wish your portfolio was constructed? Once you've figured that out, then I would create that portfolio over time.

03/14/08 by Chris Farrell

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Questions answered on air for June 7-8

In this edition of Getting Personal, Chris and Tess talk about private mortgage insurance, 457s vs. 403(b)s, removing a co-signer and borrowing from a 401(k).

Listen to this week's segment

Continue reading "Questions answered on air for June 7-8" »

06/07/08 by Richard Core

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Frontload 401(k) contributions?

Question: I am a married 31-year old. I am a corporate lawyer and my husband is an entrepreneur. I'm in the process of setting my 401(k) contributions for 2009. In the past, I've always contributed up to the annual limit (my employer does not match, but it does invest profit-sharing in my 401(k) account) spread out over the course of the year. This year, I'm considering front-loading my contributions so that my annual contribution of $16,500 is taken out of the first 8 or so paychecks of the year.

I'm considering this because (1) I'd like to take advantage of the market's current low prices; (2) we have enough in liquid assets that I can afford to take home a smaller paycheck for the first three or four months of the year; (3) I'd prefer to make the contribution while my job and income are stable -- who knows what could happen as the year progresses?

In addition, about half of my annual contribution will be in the form of a Roth 401(k), rather than a traditional pre-tax 401(k).

Are there any risks with this plan? Should I avoid frontloading my contributions? Emily, San Francisco, CA

Answer: I can't see anything wrong with what you want to do, but there is a trade-off. If you keep making the same contribution throughout the year, you're dollar cost averaging. That means you're putting the same amount of money into your 401(k) on a regular basis. The true advantage of dollar cost averaging isn't financial, bit psychological. Dollar cost averaging takes emotion --fear, greed, and panic--out of investing.

What you want to do is make a small bet by frontloading your contributions that the market is currently undervalued, and that you'll come out ahead compared to regular dollar cost averaging. I'm sympathetic to your point of view. If you're right, and the market does rebound over the course of next year, you'll come out ahead. If you're wrong, you'll be slightly worse off. That's the risk or trade-off.

There is a wonderful passage in Reminiscences of a Stock Operator written in 1923 by Edwin Lefevre. (It's a fictionalized biography of Jesse Livermore, the famed 19th century speculator.) Lefevre tells this story: Somebody asked Baron Rothschild, the great merchant banker, wasn't it difficult to make money on the Bourse (the French stock market)? The Baron replied that, "on the contrary, he thought it was very easy." "That is because you are so rich," objected the interviewer. "Not at all," said the Baron. "I have found an easy way and I stick to it. I simply cannot help making money. I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon."

In a sense, whether you frontload your contributions or stick with the normal payment schedule, you're following Baron Rothschild dictum. Good luck.

12/03/08 by Chris Farrell

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No more 401(k) match

Question: Can a company that has been contributing matching funds on a 401K plan created by the company, suddenly stop contributing claiming economic conditions? Bert, Chatsworth, CA

Answer: Yes, a company can cancel its match. There's no legal requirement that companies offer a match, and firms are free to reduce it, suspend it or even eliminate it at any time. For instance, at the beginning of November the troubled automaker General Motors suspended its match into the company's 401(k). Other companies have followed suit. Right now, many people are getting hit by a double whammy with their retirement savings plan. First, their portfolios are in the tank thanks to the 40% decline in the stock market from last year's peak, and now they're losing the match, which is the real financial benefit of a 401(k), 403(b), and other so-called defined contribution savings plans.

That said, very few companies have eliminated the match. What's more, looking at the list of companies that cut down or suspended their match during the 2000-2001 recession nearly all of them resumed payments once economic conditions improved.

You should still continue saving for retirement in your 401(k) plan even if your company does stop contributing to it. A 401(k) plan is still an easy way to save for the long haul and it's a tax advantaged way to salt away money for later in life.

12/09/08 by Chris Farrell

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Bail on 401(k)?

Question: I'm 54 years old with a 401k plan that is pretty much all my savings. I'm married and together we make approx. $80.000/year. We just recently put our two girls through college. In the last year my 401k has lost a third ($90,000)in a conservative very diversified fund. My question; do I cash out my 401k, pay the 10% penalty and put the money in my checking account that gets 5.00% interest? Thanks for your help. Jim, Clarksburg, MA

Answer: No one likes to see their hard-earned money fall sharply in value. It's tough to watch. But I'd leave your retirement savings alone. I certainly wouldn't pay the 10% penalty to get at the money unless I was standing on the financial precipice and it was the only way to prevent my family from falling. After all, you're still young and time remains on your side. You have a long time before it's time for you to consider retiring, let alone start making withdrawals.

A couple of thoughts: First, you could put new contributions into conservative fixed income investments. Second, you could stop funding the plan for a bit if you need to build up emergency savings. Again, it would be preferable if you did continue to save for your retirement. Hopefully, with your two children out of college you have some extra cash around to save outside of your 401(k). Third, I would take advantage of this experience to decide what you want to invest in with your retirement savings once the economy rebounds and the market turns up. (Yes, I am an optimist.) Last, it would still be better if you went even more conservative with the money in the fund--but still not take it out.

In the future, it seems to me that you might want to allocate more of your money into conservative options--such as Treasury Inflation Protected Securities--that preserve the value of your savings.

I think any of these options would be better than taking the money out of the 401(k) and putting it into a checking account.

12/15/08 by Chris Farrell

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Join retirement savings plan?

Question: Hi Chris. I have the option to enroll in a retirement plan at the company I work for. In light of the current stock market turmoil, I am a bit weary to enroll and wonder, is it worth it? I do have options of safe, moderate or risky investments, but they all seem a bit risky now. I am a 29 year old, earning about 41000 a year and the only debt I have is student loans, lots of student loans. Thank you for your insight. Janet, Minneapolis, MN

Answer: It's definitely worth it to participate in the retirement savings plan at work--especially if your company matches at least part of your contribution. I think even those financial planners and market forecasters that expect years of low returns and bad markets ahead of us would agree with that. The "match" is where much of the return comes from in a retirement savings plan.

Still, even if your company doesn't match your contribution, I would join the plan. For one thing, it's pretax dollars that goes into the retirement account. For another, the automatic withdrawal from your paycheck makes it remarkably easy to save, something most of us find difficult to do even with the best intentions.

I feel less strongly about which investment option you choose, although I want to stress the importance of building up a well-diversified portfolio. It's impossible to know if the market is hitting bottom now--or might do so in a year or even two. That's why the old proverbs that preach diversification and dollar-cost averaging remain wise counsel to anyone investing for the long haul. Diversification isn't a hedge against any financial crisis over a short period of time, but it's a smart strategy over any length of time. By mixing stocks, bonds, and other assets you can earn the highest potential return for the amount of risk you're willing to accept.

The benefits of diversification in reducing risk have long been recognized. A passage from the Talmud says, "A man should always keep his wealth in three forms; one third in real estate, another in merchandise, and the rest in liquid assets." Antonio in the Merchant of Venice slept soundly because, "My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year." Ideally, some of the assets in your portfolio will zig when others zag. Since no one really knows which markets will soar or sink, investing in all the major asset classes creates an opportunity to limit the damage from a downturn and to be in a position to catch the next big market upturn.

However, if for now your not sure what to do, join the plan, put the money into very safe assets, and then figure out over time how you'd like to create a diversified portfolio.

12/22/08 by Chris Farrell

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No match for 2008?

Question: My company just announced that they are canceling the 401K match for all of 2008. It is now middle of Jan 09. I understand that they are free to cancel matching at anytime, but to cancel the match for all of the past year's contributions? Is this legal? Christina, Los Angeles, CA

Answer: A growing number of companies are saving money by reducing or eliminating the company match, including General Motors, FedEx, Eastman Kodak and Frontier Airlines. The typical matching contribution in a 401(k) or comparable savings plan is 50 cents for every $1 the employee puts in, up to 6% of the employee's contribution. Of course, some companies do more and some do less. Companies are desperate to conserve cash and hold on to employees, which is why they get rid of the match. But from a public policy point of view it's a terrible move.

Now, most publically traded companies that have suspended their match have done it going forward. But what happened to you can be done. It all depends on the plan's details. (The law gives companies enormous flexibility when it comes to their retirement savings plan.) For instance, when your employer set up its retirement plan it had a choice between providing a "fixed" match or a "discretionary" match. The most common--the one we're familiar with--is a fixed match contribution. But with a discretionary match (or profit sharing match) the company doesn't have to do it if dismay sets in among management after tallying up the results for the year. Your employer realized the profit wasn't there, and it took advantage of its "discretion" not to fund the plan.

A sign of the times? According to a recent the Wall Street Journal story Starbucks switched starting Jan 1, 2009 to a "fully discretionary match" from a "fixed employer match." In other words, the company can decide whether or not to match contributions into the retirement plan.

01/23/09 by Chris Farrell

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Transfer retirement savings?

Question: I know that we're supposed to do an "institution to institution" transfer when we roll over our 401K from one employer's plan to another, but I'm wondering if I should be rolling over my 401K balance from my previous employer at all in this current economic climate. I'm still fairly young (I'm only 41), so my 401K plans are still heavily weighted toward stocks, and I can't help but feel that if I transfer funds out of a mostly stock-based 401K I'm essentially "locking in my losses," even if I'm transferring those funds into another mostly stock-based fund where I'd be buying in at bargain prices. Is the convenience of having all my eggs in one employer's plan worth ignoring my (possibly irrational) fear of locking in losses? Packy, Jersey City, NJ

Answer: You shouldn't be locking in losses with the transfer, although there will be some minor "frictional" costs that will fade with the passage of time. I'm assuming you'll be able to transfer the money reasonably quickly from your previous 401(k) plan into your new 401(k). I'm also supposing that you'll transfer the savings into comparable investment portfolios. The frictional costs come from the inevitable time gap from moving the money, and the market could move agasint you during that time. Of course, it could also shift in your favor. There may be some other minor cost incurred if the investment options aren't exact mirror images of one another.

My general bias is for you to take control of the money by transferring it into your new 401(k) plan at work. (I'm assuming your new employer allows the new money to come into the plan; if not you can always do a rollover IRA.) Now, your previous company will live up to its obligations and behave ethically toward your retirement portfolio. That's not my concern. (And if there is a worry about management I'd get the money out as fast as possible.) It's really a question of control. It's your money and if it's under your control you'll watch it more carefully.

To emphasize a point you made, there are no tax consequences or penalties imposed by Uncle Sam if the money is transferred from your former plan directly into the your new 401(k). Check with human resources at both companies before you do anything to make sure you understand any transfer requirements.

There is one good reason for keeping your money in your former employer's retirement plan: If it has good low cost investment options, perhaps even better than your current plan. If that's the case leave the money alone for now.

04/22/09 by Chris Farrell

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When is the company match mine?

Question: I was part of a "downsizing" in late January from an IT software vendor in New York City. During my tenure at the firm I was contributing to the company 401k program which has a matching and vesting component. Now that I am no longer working at the company, how does the vesting and company match work out? (Incidentally on January 1st, the company stopped matching in the 401k -- but most of my contributions predate that event.) In calling the 401k company it sounds like I will not receive the company match and vesting. Is this true, even though it was not my choice to leave the company? I wanted to check before rolling my 401k over to my IRA. There is a 6 year vesting period, and I am fairly happy with the low expense ratio index fund selected in the 401k. PS. I was only out of work for a few weeks. Seth, Forest Hills, NY

Answer: I'm glad you got another job so quickly. That's terrific. By law, any money you contributed to the 401(k) plan is yours. Period.

The issue with vesting is determining when the company's "match" becomes your money. It's a basic equation. It's partly decided by how long you've worked at the company and partly by the vesting schedule the company adopted. The two most common types of vesting timetables with 401(k)s are the "graded" and the "cliff".

Here is the minimum "graded" vesting timetable:

1 year of work: 0% vested
2 years of work: 20% vested
3 years of work: 40% vested
4 years of work, 60% vested
5 years of work, 80% vested
6 years and after, 100% is vested.

An alternative is the "cliff" vesting schedule:

After 2 years of work: 0% vested
After 3 or more years, 100% vested.

These percentages are the minimum standard companies must follow by law. But companies are allowed to be more generous if they choose. For instance, about a third of employers have 401(k) plans with the company match immediately owned by the employee. A four year vesting schedule is fairly common, too.

Now, when it comes to vesting it doesn't matter why you left the company, voluntarily or by being laid off. (The latter in your case.) So, from your email it looks as if you are under the 6 year 100% vesting rule. I'd check out the details of your plan and hopefully you're at least partially vested.

06/12/09 by Chris Farrell

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After-tax retirement savings

Question: The company I work for offers a 401k, both normal pre-tax contributions and after-tax contributions, and also a Roth-401K. Can you please explain the differences between the Roth-401K and the post-tax contributions to the normal 401k? Erik, Tulsa, OK

Answer: Yes, in both instances you're making after-tax contributions. There are a number of differences between the two options, but I want to highlight the critical one that becomes apparent in retirement.

When you take the money out of the Roth-401(k), assuming you are at least 59 ½ and have owned the account for 5 years or more, the investment gains are free of Uncle Sam clutches. The same isn't true for withdrawals from the after-tax account in a traditional 401(k). There isn't any tax levy on the amounts you contributed, of course. But you will pay ordinary income taxes on any investment earnings or gains at withdrawal.

By the way, in most cases it makes more sense for savers to open up a Roth-IRA on their own rather than put extra retirement money into an 401(k) after-tax account, assuming your employer offer the option. The reason is the value of withdrawing money free of taxes in old age with the Roth.

06/16/09 by Chris Farrell

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Early withdrawal from 401(k)

Question: Is it possible to move the majority of my balance in my company's 401k to a self-directed IRA without penalty (or quitting my job)? I'm not happy with the investment alternatives available in my company's 401k plan. David, Lewis Center, OH

Answer: In most cases the answer is no. The general rule is that employers aren't supposed to let you take money out of the 401(k) and roll it over into an IRA. You can only do that when you leave the company--voluntarily or involuntarily.

However, there is one important wrinkle (hey, legislators can't make saving for retirement simple, can they?). By law, companies can offer their employees 59 ½ or older the option of rolling over their contributions into an IRA. It's called an "in-service" distribution. In other words, you're still working for the company, you're 59 ½ or older, and you can roll the money over into an IRA. It's legal, but it's up to management whether they offer the option. A majority of large companies seem to allow it.

To learn more about the twists-and-turns in the in-service distribution world, check out this detailed article in Forbes: The Great 401(k) Escape.

09/10/09 by Chris Farrell

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401(k) money

Question: Do I have to remove my money from my 401k when I retire from my company (UPS) even if I don't need it at the time of retirement? I know I can't contribute after I leave but is it ok to leave the money in there till I need it or this market turns around... (I'm being optimistic!) Patricia, Cleveland, OH

Answer: I like your optimism. The law gives company's a great deal of leeway when it comes to their retirement savings plan. The terms of the plan may say its fine to leave the money where it is for now or it may call for a fairly quick withdrawal. So, place a call to human resources and you'll get you the answer you need right away.

09/17/09 by Chris Farrell

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Rollover IRA

Question: I was recently laid off and told that because my 401k balance was below 5k I would need to move the money. I do not want to cash out and would like to avoid paying any taxes on the funds. I currently have 3 other 401k accounts with previous employers. What are some of my options for these investments? Natalie, West Chester, OH

Answer: You'll want to do what's called a "rollover IRA." There are no tax consequences or penalties so long as the money is transferred from your former employer directly into the rollover IRA account. Check with human resources before you do anything to make sure you understand any requirement the company may have about a rollover. The same goes with the company you've chosen to place your rollover IRA. And if you put the money into a comparable investment you shouldn't take much of a hit on the transfer, either.

Now, as to your other 401(k) accounts at 3 previous employers, why are you keeping the money there? If it's because you really like the plan options offered by these employers, fine. But my bias is for you to take control of the money through a rollover IRA. "It's great anytime you can take control of your money and take it out of your company plan," says Ed Slott, head of his eponymous company and a leading IRA expert.

You're no longer working for these companies. It's your money and if it's under your control you'll watch it carefully. Plus, you get to chose the investment company and investment options, not your former employer.

10/21/09 by Chris Farrell

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