401K

by Edwin Ivanauskas | Tags: Personal Finance, Investing, Retirement

A 401K is a retirement plan sponsored by your employer. It is a defined contribution plan where you contribute a certain portion of your income into the account. 401K accounts are popular because of two main reasons.

As a retirement investment, the 401K has both advantages and disadvantages:
Pros:

• Tax deferred until withdrawal.
• Possibility of additional contributions from employers

Cons:

• Withdrawal penalties of 10% with certain exceptions.
• Lack of liquidity if the contributor needs the money for another purpose.

A further comparison of a 401K plan with other investments can be found here.

Benefits of a 401K

First they are a tax deferred plan, as an example let's say you put $4,000 dollars into the account over a year and earned $54,000 that year, only $50,000 would have to be claimed as income. On the other hand, the benefits upon withdrawal once you've retired are taxed as income. Second, employers may offer a matching contribution giving you a strong incentive to deposit into the 401K account because of the increase in assets gained if employers match the deposit.

The tax deferment option can be advantageous because retirees generally require fewer expenses than during their career so can live off of a smaller yearly income. This drives them to a lower tax bracket so they have to pay less on the withdrawals from their 401K than they would have paid during their working years.

Although a 401K is an employer provided benefit, if you were to change employers and your new employer has a 401K plan, you can transfer your old 401K plan to the new employer. If your new employer does not offer a 401K plan, it can be transferred to an IRA at another institution or the old employer may charge a fee to keep the 401K managed through them.

The money deposited in a 401K is distributed among a variety of assets that could include stocks, bonds, mutual funds, money market funds and others. The options available are based on the specific plan your employer allows and the proportion of funds in each can be regulated by the contributor manually.

Deposit Limits

401K contributions are limited to a maximum of $16,500 a year in 2009. People age 50 or older are allowed an exception to this limit in the form of "catch-up" contributions. These catch up contributions are limited to $5,500 in 2009. These limits are also imposed if more than one 401K (such as a traditional and Roth) are owned by the same person, there can be no more than $16,500 contributed to both accounts combined. These limits are set by the IRS and can differ from the limits set by your employer's plan which may limit it based on a % of yearly income.

Withdrawing Funds from a 401K

The current age requirement to begin withdrawing funds from a 401K is set at 59 ½. At this point withdrawals can freely be made with no penalty, but an income tax must still be paid. If withdrawals are made before this point, there is a 10% tax added on to the income tax for the withdrawal.

There are a few exceptions to this rule. Some plans may allow the employee to take a loan out from their 401K plan. Loan conditions can vary greatly based on individual plans offered by employers but won't exceed 5 years and will be a reasonable income rate. The income is then paid back and added to the 401K account but does not get the tax deferred treatment that regular deposits get.

In addition to the available loan, 401K plans will not suffer the 10% withdrawal fee if the contributor dies, is disabled or cannot work any longer. If upon leaving the employer which holds the plan, the employee cannot find another plan to transfer the funds to such as an IRA or a new 401K, the funds can be distributed without penalty.

Types of 401K plans

All of the above information was in reference to a traditional 401K plan, the following is a list of non-traditional 401K plans available and how they differ from the traditional plan.

Roth 401K

A Roth 401K differs from a traditional 401K primarily in that it is does not have a tax-deferred contribution. This means that an income tax is paid on all income before the contribution is made but at the time of withdrawal, no income tax is paid. There are additional restrictions associated with a Roth 401K. The $16,500 limit is imposed on a combination of traditional and Roth 401K that an employee may have so they cannot invest $16,500 in two separate accounts.

SIMPLE 401K

This is a type of 401K plan available to companies with 100 or fewer employees. The employees eligible must have received at least $5,000 in pay from the company in the last year. Traditional 401K plans have a requirement for the employer to test whether the higher compensated employees in the company are being treated as equally as lower paid employees. The SIMPLE 401K eliminates those testing requirements so allows small businesses to provide retirement benefits to their employees without high costs. One difference is that the SIMPLE 401K has a lower limit of $11,500 contribution per year in contrast to the $16,400 limit in a traditional 401K.

401K plans are popular among employees and are the major source of retirement income for 44% of all workers. It is important when planning for retirement to understand the different options available and fitting them to your personal preferences. You can read more about how a 401K fits into saving for retirement and retirement investing

Bonds

by Edwin Ivanauskas | Tags: Investing

Investing in a bond is a safer and less risky alternative to other investments such as stocks or real estate. Generally bonds are issues by both companies and governments.

So in other words we can say, that bond is a kind of loan, where the issuers the one who borrows and the holder is the one who lends, and the interest added is the coupon. Bonds can prove to be a good source to provide the borrower with funds to finance the long term investments. Also they may be of help in financing the current expenditure.

Why issue bonds?

Companies and governments both issue bonds for the same reason, as a way to raise capital. Companies can use bond issuance instead of stock issuance to raise capital while governments cannot issue stock as they have no equity to distribute. Bonds can potentially bring in more capital than a bank loan could and can be cheaper for the company than stocks.

How Bonds Work

Bonds have a variety of features that help determine their value to the investor.

• Face Value - this can also be called the nominal amount, face amount or principal value. This is the amount that the bond issuer has to pay at the end of the bonds life.
• Maturity - this marks the end of the bonds life and is the point at which the issue must repay the face value to the borrower. Companies can issue a wide variety of maturity's on their bonds but U.S. government sticks to a tiered system. Treasury bill mature in up to one year, Treasury notes mature between one to ten years, and Treasury bonds mature in ten years or more.
• Coupon - this is another name for the interest rate. The issuer of the bond agrees to pay the fixed interest rate on the bond every year until maturity. The coupon rate is fixed throughout the life of the bond and, along with the face value, is how investors value the bond after it has been issued.
• Issue Price - This is the price of the bond when a company or government issues the bond. This value is given by an equation calculating the present value of both the maturity and coupon rate.

Calculating Bond Value

Bonds are fairly simple instruments to calculate when they are issued. Let's assume that a 20 year bond is being issued by a company with a face value of $1000. The company agrees to pay a $30 a year coupon on the bond until maturity. This gives an interest rate of 3% (30/1000). Let's also assume that the market interest rate on similarly risky investments is 3%, the same value as the bonds coupon rate. The numbers are then applied to a formula generally using a financial calculator and the resulting Issuance price is $1000. In this case the issue price is the same as the face value and the bond issuer is paying the borrower for the time value of that money.

Bonds can be freely traded on the market at any point in their lifespan. This requires investors to know how to calculate a bond's value at the time of purchase. There are three different categories a bond can fit into when it's being sold after its issuance.

• Par Value - The primary indicator of a bond's value is the coupon rate it pays out to the holder. This coupon rate is compared by investors to the market interest rate. In a situation where a bond is at par value, the market interest rate and the bond's coupon rate are the same. In our earlier example this would mean that the coupon rate is 3% and a few years down the line, the market interest rate is also 3%.
• Premium - A bond is considered to be a premium bond when the interest rate on the bond is higher than the interest rate in a market, this generally occurs during a recessionary period. An example of this would be that 5 years after issues, our 20 year bond is still paying out 3% or $30 on its $1000 face value as the coupon rate does not change throughout the life of the bond. But the market interest rate happens to be only 2%. After entering this into a financial calculator, the bond is valued at $1128.49. This price is increased because a bond which is at a premium value is yielding more interest than an investor can normally get from the market, therefore it is worth more.
• Discount - A bond at a discount rate is the exact opposite of a bond at a premium rate. In this example let's assume that 5 years down the road, the market interest rate is 4% due to good financial times and an upturn in the economy. The bond features are all the same at a coupon rate of 3% and a face value of $1000. Calculating the price of the bond now gives a value of $888.82. This price is now lower because the bond is yielding less than an investor can get on the market therefore would not be willing to pay the full face value for a worse investment.

Business Insurance

by Edwin Ivanauskas | Tags: Personal Finance, Investing

Whether you have a small two person family owned company or a business with four hundred employees, you need Business Insurance. You cannot protect yourself and your business without it. Sad to say that if someone trips over a crack in front of your store or if they were to fall on a piece of carpet that was slightly lifted, you are at risk of losing everything that you have worked for. We live in a lawsuit happy world where it is not if you will get sued but rather when you will be sued.

Businesses are arguably at a higher risk from people looking for ways to make an easy dollar off of a mistake that they think you have made whether it is in a business transaction or a sidewalk not cleared leading to your door. No one likes to think of this, yet it is what you need to think about when deciding the types of insurance that you need to carry to protect yourself and your business.

Surety Bond

This is a insured bond that protects your business for a certain dollar amount. This is also used in government contracts. For instance if you have a loan company and you are sued, you must have a surety bond that the government recognizes in case you are sued by a customer. This insures that if you lose that case, the government has the right to access that money to pay that client.

Liability

This type of insurance protects your small business from ruin if you are sued from someone getting hurt or thinking that you have done some type of service wrong according to their contract. This will protect you and help with the legal fees which will accrue.

Flood insurance will protect your business from water damage due from natural flood damage or if the sprinklers go off and ruin your office.

Casualty Insurance

This type of coverage covers the loss to a business. If you have damage to your business belongings or property then casualty coverage covers this.

Auto insurance

Insurance for any company owned vehicle that you may use for the business. This is especially needed when you have multiple drivers using company vehicles for deliveries, etc.

Depending on the size of your company an Insurance agent or broker is someone who can help you decide which Business Insurance you will need and how much based on the type of business that you have and how large your company is. A package insurance plan is more economic for you as a business owner and will help keep your business needs in perspective. Insurance is as important as the business you are in and there is never enough of it. Take the time to research and discuss your Business Insurance needs with your agent or broker and make sure that you are getting the best insurance for your money. It is well spent.

Mutual Funds

by Edwin Ivanauskas | Tags: Personal Finance, Investing

Mutual Funds are a form of investment that differs from other investments in that they are a large pool of investments that individuals can purchase portions of. Mutual funds are generally founded on the idea of an investment portfolio in which investors attempt to diversify their investments widely to control for risk or to focus on investments they are comfortable with.

There are a variety of mutual fund types available that operate somewhat differently, here is a breakdown:

• Index Funds - These funds are based on a stock index such as the S&P 500 or the Dow Jones Industrial Average. Their strategy is to hold every single stock listed in their chosen index. This is advantageous because returns coincide with the performance of that index and management fees are minimal because there is no need for a manager to decide which stocks to invest in.
• Managed Funds - Managed funds are any mutual fund that has a manager making decisions on where to invest the fund's money. The idea is that the manager is so experienced with these investments that they can beat the returns in the stock market as a whole. This type of fund generally comes with management fees that are taken out of the fund owners earnings.
• Money Market Funds - A money market fund is different from other funds in that it invests in the money market rather than the capital market. The money market consists of short term financial instruments such as government debts, commercial paper, and Certificates of Deposit. These funds attempt to reduce risk by diversifying among a wide variety of less risky debt.
• Equity Funds - These are the most common types of mutual funds and can be either indexed or managed funds. The key difference is that they invest in the capital market using instruments such as stocks and bonds rather than the short term instruments used in money market funds.
• Hedge Funds - These are the most distinctly different of mutual funds. They are used by extremely wealthy participants and are rarely available to the average investor. They pool resources from investors and their actions are loosely regulated by the government. These types of mutual funds allow managers a high level of flexibility to employ whatever strategies they would like.

Retirement Accounts

by Edwin Ivanauskas | Tags: Personal Finance, Investing, Retirement

While looking at planning your retirement, you may have noticed there are a wide variety of retirement accounts available to choose form. This article will give a detailed breakdown and comparison of the different retirement accounts to help you decide which is the best choice based on your circumstances.

Individual Retirement Account (IRA)
The Individual Retirement Account (IRA) is a tax deductible defined contribution retirement account. This means that taxes are not paid that year for any money deposited in your IRA. Instead, withdrawals made from the account upon retirement are taxed as income.

Pros:

• Tax deferred until withdrawal.
• Individual, customized control of investments.
• Tax deferral of investment growth

Cons:

• Very low yearly contribution allowance of $5,000.
• 10% withdrawal penalty.
• Lack of liquidity if the contributor needs the money for another purpose.

An individual Retirement Account allows the account holder to make investments using the funds in their retirement account. This means they can allocate the funds across a variety of stocks, bonds, and mutual funds. The importance of this is that any growth in these investments is tax deferred until withdrawal along with all funds in the account.

The negative side of this tax deferral is that the growth of investments will be taxed at your income tax rate rather than capital gains which is 15%. For the tax advantage to really come through, the funds in an Individual Retirement Account (IRA) must be allowed to have time for growth. In general, it is advantageous when the Individual Retirement Account (IRA) is allowed to grow for more than 20 years before withdrawal for the tax deferral to be advantageous.

A disadvantage of the Individual Retirement Account (IRA) is the low deposit limit of only $5,000 a year with a catch-up addition of $1,000 a year allowed for individuals 50 or older. Also, funds can be difficult to withdraw from an IRA before the designated age of 59 ½ is reached. To see a more detailed analysis of an Individual Retirement Account (IRA), read our article about the Individual Retirement Account (IRA)

When is a Roth IRA for me?

The Roth Individual Retirement Account (IRA) is an account that is not tax deferred; therefore taxes are paid on any money before it is deposited in the Roth Individual Retirement Account (IRA). This can be advantageous for individuals who expect to have a higher income upon retirement so would rather pay the current lower tax rate than a future expected higher tax rate.

When is a SEP IRA for me?

The Simplified Employee Pension Individual Retirement Account (SEP IRA) is an Individual Retirement Account (IRA) specifically meant for self-employed individuals and their employees. The account is shared among all members involved and uses a profit-sharing model. The contribution limits for an SEP IRA are the lesser of 25% of income or $49,000 in 2009. All members of the SEP IRA are required to make the same contribution.

A SEP IRA can be advantageous to a business owner due to its higher contribution allowance. It is not really an option for individual retirees who do not own a business of their own. All contribution made to the SEP IRA are made by the employer and not by employees themselves. Thus, the business owner must evaluate whether the tax benefits of expensing these costs and the increased benefits to their employees are worth the cost of increasing their own retirement contributions.

Comparison of Individual Retirement Accounts (IRA) to 401k

401k and Individual Retirement Accounts (IRA) are similar in that they both are tax-deferred retirement accounts which can increase in value over time before funds are withdrawn and they both have restrictions on fund withdrawal. One difference is that the contribution limit is only $5,000 a year for an Individual Retirement Account (IRA) while it is $16,500. A 401k also has the possibility of employer contributions in addition to your personal contributions.

In general, it is a good idea to prefer your 401k plan over your Individual Retirement Account (IRA) due to the higher limits and employer contributions. Before using this as a hard and fast rule, it is best to review what types of investments are made within your employer sponsored plan and your Individual Retirement Account (IRA) and what type of contributions are made by your employer.

Comparison of Individual Retirement Accounts (IRA) to Retirement Annuity

Both an Individual Retirement Account (IRA) and a Retirement Annuity are tax deferred retirement accounts. Unlike an Individual Retirement Account (IRA) which has a $5,000 contribution limit, a retirement annuity has no contribution limits. Both accounts have a 10% penalty for early withdrawal.

The main feature a retirement annuity has that an Individual Retirement Account (IRA) does not is its variety of guarantees. These guarantees include a guarantee to receive a minimum income per year after retirement and guarantees that the accounts value will be at a minimum level in the future. But these features come at a cost of about 3% a year in fees.

It is generally a poor idea to invest in a retirement annuity rather than an Individual Retirement Account due to these high fees charged. If the benefits being offered are worth the 3% annual fee due to your circumstances, a retirement annuity would be something to consider looking into.

401K

A 401k is a retirement account sponsored by your employer. It is a defined contribution plan where you contribute a certain portion of your income into the account.

Pros:

• Tax deferred until withdrawal
• Possibility of additional contributions from employers
• Tax deferral of investment growth

Cons:

• Withdrawal penalties of 10% with certain exceptions.
• Lack of liquidity if the contributor needs the money for another purpose.

401k and Individual Retirement Accounts (IRA) have a variety of similarities. They are both tax deferred plans to taxes are only paid on withdrawals from the account, allowing a tax-free buildup of funds and investment returns. This tax deferred features of both retirement accounts is advantageous to retirees who expect a lower income upon retirement than the income they receive during their careers.

A very large advantage of a 401k retirement account is that your employers may have a benefit where they will add funds to your account or match funds you add to the account. This is the primary advantage that a 401k has over an Individual Retirement Account (IRA) but is highly dependent on what your employer contributes.

As with the Individual Retirement Account (IRA), the 401k has a negative side if the account holder does not allow the account to be active for more than 20 years. This is due to the growth within the retirement account's investments being taxed at your income rate upon withdrawal rather than the customary 15% capital gains tax on investments. The tax advantages on investment growth are only seen after a long period of time.

When is a Roth 401k for me?

A Roth 401k, unlike a standard 401k retirement account, is taxed before the funds are placed into the account and withdrawals are made tax free. As with a Roth Individual Retirement Account (IRA), the Roth 401k is advantageous to individuals who expect their income upon retirement to be higher than their career income, therefore the tax-deferral of a standard 401k can be a negative to them.

To find out more in-depth information about 401k retirement accounts, read our article about 401k.

Comparison of 401k to Individual Retirement Account (IRA)

401k and Individual Retirement Accounts (IRA) are similar in that they both are tax-deferred retirement accounts which can increase in value over time before funds are withdrawn and they both have restrictions on fund withdrawal. One difference is that the contribution limit is only $5,000 a year for an Individual Retirement Account (IRA) while it is $16,500. A 401k also has the possibility of employer contributions in addition to your personal contributions.

In general, it is a good idea to prefer your 401k plan over your Individual Retirement Account (IRA) due to the higher limits and employer contributions. Before using this as a hard and fast rule, it is best to review what types of investments are made within your employer sponsored plan and your Individual Retirement Account (IRA) and what type of contributions are made by your employer.

Comparison of 401k to Retirement Annuity

401k and Retirement Annuities are both tax-deferred accounts in which the funds are only taxed upon withdrawal. 401k retirement accounts have an annual limit of $16,500 while a retirement annuity has no annual limit.

The main feature a retirement annuity has that a 401k does not is its variety of guarantees. These guarantees include a guarantee to receive a minimum income per year after retirement and guarantees that the accounts value will be at a minimum level in the future. But these features come at a cost of about 3% a year in fees.

It is generally a poor idea to invest in a retirement annuity rather than 401k due to these high fees charged. If the benefits being offered are worth the 3% annual fee due to your circumstances, a retirement annuity would be something to consider looking into.

Retirement Annuity

A retirement annuity is a defined contribution retirement account sold exclusively by life insurance companies. The earnings within a retirement annuity are tax deferred until withdrawal. Insurance companies can offer a variety of guarantees with their retirement annuity products, but these benefits come with extremely high fees.

Pros:

• Tax deferred growth within account
• Guaranteed benefits
• - No limits like a 401k or Individual Retirement Account (IRA)

Cons:

• Extremely high fees
• Lack of liquidity, 10% early withdrawal penalty

The main benefits of retirement annuities are the guarantees that life insurance companies provide. These can include a guarantee that you will receive a minimum income per year after retirement and guarantees that the accounts value will be at a certain level in the future. The income earned within an annuity is tax deferred upon withdrawal providing a tax shelter for potential investment growth.

These benefits come at a cost. The fees charged on annuities can be extremely large and are highly criticized in the financial world. The total amount of fees charged on an annuity are around 3% a year, a far cry from the 1% a year charged by mutual funds directly. To read a more in-depth breakdown of retirement annuities and the fees charged, read our article on Retirement Annuities.

Retirement Annuities become advantageous when an individual is willing to deal with the 3% fees to acquire the potential guarantees.

Comparison of Retirement Annuity to Individual Retirement Account (IRA) -
Both an Individual Retirement Account (IRA) and a Retirement Annuity are tax deferred retirement accounts. Unlike an Individual Retirement Account (IRA) which has a $5,000 contribution limit, a retirement annuity has no contribution limits. Both accounts have a 10% penalty for early withdrawal.

The main feature a retirement annuity has that an Individual Retirement Account (IRA) does not is its variety of guarantees. These guarantees include a guarantee to receive a minimum income per year after retirement and guarantees that the accounts value will be at a minimum level in the future. But these features come at a cost of about 3% a year in fees.

It is generally a poor idea to invest in a retirement annuity rather than an Individual Retirement Account due to these high fees charged. If the benefits being offered are worth the 3% annual fee due to your circumstances, a retirement annuity would be something to consider looking into.

Comparison of Retirement Annuity to 401k

401k and Retirement Annuities are both tax-deferred accounts in which the funds are only taxed upon withdrawal. 401k retirement accounts have an annual limit of $16,500 while a retirement annuity has no annual limit.

The main feature a retirement annuity has that a 401k does not is its variety of guarantees. These guarantees include a guarantee to receive a minimum income per year after retirement and guarantees that the accounts value will be at a minimum level in the future. But these features come at a cost of about 3% a year in fees.

It is generally a poor idea to invest in a retirement annuity rather than 401k due to these high fees charged. If the benefits being offered are worth the 3% annual fee due to your circumstances, a retirement annuity would be something to consider looking into.

Retirement Accounts Conclusions

Overall 401k retirement accounts provide the best variety of features for retirement. Individual Retirement Accounts (IRAs) are very similar to 401ks but lack the benefits of employer contributions and have lower contribution limits. It is best to deposit all funds available into your 401k until the limit is reached and if your income allows it, contribute the remainder into your Individual Retirement Account (IRA).

Retirement annuities are widely criticized and rightfully so. They provide a few features that may entice individuals to contribute but those features come at a very hefty price that isn't associated with any other type of account. Retirement annuities should only be used if your individual life circumstances make the features they provide a worthwhile sacrifice of 3% in fees every year.

In addition, each type of 401k and Individual Retirement Account (IRA) is different based on who is providing the account. This would be either your employer for a 401k or a financial institution for your Individual Retirement Account (IRA). They all provide different ways in which to manage the investments within the fund itself.

Only general recommendations can be given about which of these three main types of retirement accounts are best for individuals. Decisions must be made in an informed way while taking into account very specific circumstances of the individuals planning their retirement and deciding which retirement accounts are right for them.

To read more about how these accounts fit into retirement investing and saving for retirement, read our article about retirement investing.