You’ve been investing in your 401k for quite some time and are probably still clueless in where your money is going.  (Don’t worry…you’re not alone)

But you’re thankful that they offer these “target date” or “life cycle” funds that make investing in your 401k so easy.

What are target date funds? You know… the funds where all you have to do is choose the year you plan on retiring and voila – you’re all set.

Winner, winner, chicken dinner…..how easy is that?

Here’s the BIG problem.  Target date funds, although easy, can sometimes eat away at your returns.

Or stated just a bit more bluntly– They suck!

*You know I hate Target Date Mutual Funds when I take the time to record a video.

Target date funds were created to take away the hassle of having to research the mutual funds in your 401k and build and construct your own portfolio. But in my experience, taking the time to do the research and, essentially, build your own target date funds in your 401k, is a much better option.  It’s this “a la carte” approach that can potentially give you much higher returns over your working life.

 What Makes Target Date Funds so Bad?

First, let’s understand how they work.   Most often these funds are created by a specific mutual fund company.   Then that mutual fund company will take 12-18 of their mutual funds and create this diversified portfolio on your behalf.  As you age towards your “target date” of retirement, the 12-18 funds will start shifting to something more conservative (movi.ng from less stocks to more bonds)

Sounds like win-win, right? You would think.  Here’s the problem….

When you start breaking down the individual mutual fund options inside these target date funds, you start to uncover that there are some or several of these funds that are just plum horrible.

 What I’ve Seen With Target Date Funds

Over the years, I’ve seen countless target date mutual funds that my clients have brought in and thus far, I haven’t seen one that I’ve been impressed with.

Recently, I had three different clients bring in their 401(k)’s, all of which having target date funds.

The common theme was…..you guessed it…. they suck.

Show Me Some Examples

Here’s some examples of three clients’ 401(k)’s where we compared the target date portfolio and looked at their ten-year returns, we adjusted that for inflation, and see how that compared with the new portfolio.

Now, keep in mind, the new portfolio consisted of the mutual fund options that were available to them in their 401k.

See, whenever you have a 401k, the target date fund is usually the easiest option, and sometimes your default option, but you typically have the ability to go in and create your own portfolio.  Most people don’t because they simply just don’t know and don’t feel comfortable doing it.

I can’t blame people for not feeling comfortable or qualified to do so.  I’m hoping by showing you some numbers below that you’ll at least consider it.   Let’s take a look…..

Sample Client One

With each client we kept the ratio of stocks and bonds relatively the same.   As you can see,  the first portfolio netted a 3.61% more return over a 10 year period.  3.61%!  Remember, we are just using other mutual funds that are already in the 401k.

For the super analytical people, I had to include other factors as beta, standard deviation and alpha.  If you don’t know that means, it’s OK.   You don’t need to.   What you may be more interested in dollars.

What does 3.61% really mean over the long term? Well, let’s just say… A LOT. As you can see below, in 5 years on a $100,000 portfolio, it’s over $22,000. Wow! And as you can see it only gets bigger and BIGGER….

Those numbers don’t really reflect what happens in a 401k. If you have a 401k, then most likely you’re adding to it on per paycheck basis.

Using the same returns, I wanted to demonstrate if you were adding $5,000 per year into it. As you can see the 20 year number is a $295,000 difference. Okay, that deserves a special call out……

Still think you’re target date fund is good enough for your retirement?

Sample Client Two

You can go through the rest of the examples and see more of the same. What’s the recurring theme? You guessed it. Target date funds suck.

Sample Client Three

Different Client. Different 401k. Different target date mutual funds. Same sucky results….

Portfolio	10Yr Return	Adjusted for Inflation Assumed(3.4%)	10Yr Beta
Target Date Portfolio	5.55%	2.08%	.98
New Portfolio	7.78%	4.26%	.89
Difference	+2.23%	+2.18%	-.09

Managing Your Own 401k

Now, I understand that most people don’t know what the heck they’re looking at in their 401k, so it’s hard for them to do their own research, but that’s where a financial planner comes into play.

Find an advisor that knows that they’re doing and have them construct you an optimized 401k  portfolio.  Even if you have to pay that person $1000 to help with your 401k, that $1000 is nothing, especially when you look at the numbers above.

401k Review Service

Since I realize people need help with their 401k, it only made sense to include that as a part of my practice.   Don’t worry, it’s not $1000.  If you need help with your 401k, check out my 401k review service.

There are reasons for relief in some quarters since the IRS release its official 2011 regulations for 401k, 403b, and other retirement plan contribution limits. This information is renewed annually based the 2011 cost of living adjustment figures. The good news is that the cost of living adjustment (COLA) numbers have stayed the same. This makes a three year period of relative stability in contribution limits. There were some fears circulating that the limits were supposed to be lowered for 2011.

Each October the limits are re-calculated using a formula that is based on the inflation rate (which is connected to the COLA figures) in the third quarter versus the previous year’s quarter performance.

401k Contribution Limits for 2012 (Traditional and Roth)

With that said, it’s time to talk about possible affects on your 401k or other retirement plan. In other words, what is the maximum amount you can contribute in 2012? It stays at $17,000 for people aged 50 and younger. There is an additional catch-up contribution available as well. It holds at $5,500. The same limits apply to other plans, such as the 403b or the Thrift Savings Plan.

Keep in mind that your 401k maximum contribution limit is based on the combine total that you can make annually for all of your plans, regardless of whether they are standard plan configurations or Roth 401ks. The matching contributions made by your employer are not included in these final 401k contribution limits. This applies even if you contribute the maximum every year. The matches are added despite the 401k limits.

Save, save, save!

As a reminder, the above limits apply to both Traditional 401k’s and Roth 401k’s

Make Sure You’re Doing Your Part

Despite the fact that these higher limits have been available since 2009, many workers haven’t used them. Much of this can be explained by the market crash. Few people were ready to assess their 401ks in such a dismal economic environment. They chose to ignore this option. Still, employer-sponsored 401ks and IRAS remain a good form of long-term retirement investment. It’s largely a matter of compound interest, generous employer matches, and associated tax deductions. If you will use the new 2012 to plan for higher contributions, you can end up earning better retirement savings in the future.

Such policies may provide people with options for creating better tax strategies when taxes are on the rise. It may also be of service once the Bush-era tax cuts finally expire. The sluggish performance of the economy and other forecasts suggest that inflation may remain in the 2% range for a while. What this means for 401k limits is that the rate’s generally flat growth rate will lead to a similar percentage increase in future retirement account contribution limits.

Most people never need to worry about a special category of limits on 401k contributions. As a matter of fact, most people don’t even know that this category exists. However, those who have found themselves included in the highly compensated employees (HCE) category, learn quickly about the additional limits that are placed on their 401k contributions.

What Constitutes Highly Compensated Employee

In order to be considered a highly compensated employee, the employee must make over $110,000 per year (2011) AND be in the top 20% of earners within their company. So even if you are the highest paid person working at your company, if you make less then $110,000 annually, then the limits do not apply to you.

Understanding 401k Contribution Limits

Money contributed to a 401k plan is done so tax free. Therefore, in order to keep people from money, there are limits imposed on how much can be contributed per year. In 2011, the maximum individual contribution per year is $16,500. In addition to an individual contribution, employers can make matching contributions. So if an employer pays a 50% matching contribution, and the employee contributed $10,000, then the employer would contribute an additional $5000.

However, the maximum amount that an employer is allowed to contribute is 6% of the employes compensation (salary). So to use nice round numbers, if an employee earns $100,000 per year, the maximum an employer can contribute is $6000. With the 50% match program mentioned before, if an employee were to contribute the full $16,500 per year, the employers matching contribution would be $8250, however for a $100,000 per year earner, that would exceed the 6% limit, therefore the most the employer could contribute would be $6000. This would make the contribution for the year $22,500.

Individuals can contribute to their 401k on an after tax basis. The maximum total contribution for a calendar year is $49,000 or 100% of their salary (compensation), whichever is less.

Additional Limits for Highly Compensated Employees

In addition to the limits set for all individuals mentioned above, HCE’s are subject to further limitations on their 401k contribution limits. For someone who falls into the category of a highly compensated employee, meaning they make over $110k and are in the top 20% of earners in their company, the total contribution that an employer can make is limited. The limit is based on the employers overall 401k participation rate. The contribution to the pool of HCE’s can not be more then 125% of the average of all on the non-HCE’s contributions. So the amount of the contribution is really dependent on how many non-highly compensated employees are participating in the companies 401k plan.

If payments in excess of 125% were made to highly compensated employees, then the funds must be returned to the employee. The employee may use those funds to re-contribute to their 401k as a post tax employee contribution. Any post tax contributions made must be reported as taxable income for tax filing purposes.

photo credit: orudge

You work, you save, you retire – it’s the American way, right?  But what happens when you have done a good job saving and get to be one of the lucky ones to retire early – are you still subject to the IRS rules of being age 59 1/2  before you can touch your money? (Side rant: what the heck is up with the IRS and these 1/2 ages anyway? This concludes my rant.)  If you are stressed about having to pay the 10% early withdraw penalty, don’t freak out just yet.   The IRS – believe it or not – does allow methods to withdraw funds from your 401k without penalty.  Just make sure you follow the rules before you claim your prize.

A few notes before hand…

1. You always have the option to take a 401k loan (if your plan allows it).  Does that mean you should take it?  I’m hoping that you have ample emergency funds that you can tap first. Stated another way and more blunt: You BETTER have enough emergency funds. Got it? If not, make sure you know the 401k hardship rules.
2. Before you make any withdraws at of your 401k, do more than just read this post.  Consult your financial advisor and/or tax professional to make sure you have your bases covered.

Another thing, the methods shared below allow you avoid the 10% penalty, but they do not….I REPEAT…..do not prevent you from having to pay the tax.   Now that we have that taken care of, let’s see how you can withdraw funds from your 401k penalty free….

1. A Visit From The Grim Reaper

Okay, I’m sure that death is probably not the option that you wanted to hear.  I guess technically you don’t benefit.  Rest assure that your family will benefit in that they can use your retirement funds to cover burial expenses and supplement other income needs now that you’re not around.   Just make sure to update your beneficiaries << you have been warned.

2. Qualifying Disability

If you have been deemed to be disabled either buy an insurance company or Social Security, then you are entitled to withdraw from your 401k penalty free.  You’ll have to provide a disability letter to your 401k custodian to verify your status and avoid the penalty.

3. Medical Bills

A visit to the emergency room can add up really quick nowadays.  Our middle son banged his head on our bathroom doorway and we found that out really quick.  CHA-CHING!  If you don’t pay them, next thing you know you have debt collectors hounding you.   To avoid the penalty a few things have to occur:

1. Withdraw Same Year. You have to take the money out in the same year you incurred the medical bills.
2. 7.5% Rule. Take 7.5% of your AGI (Adjusted Gross Income) and that’s the to the extent that the unreimbursed medical bills that you’ll be allowed to claim penalty free from your 401k.

On a side note, it is not required to itemize your deductions to qualify for this.  If you don’t know what that means, then you better pay somebody to do your taxes for you.

And if you think that I had to tap my 401k to pay for my son’s emergency room visit, get your head out of the gutter.

4. Disaster Relief

With all the storms and flooding that have hit the U.S. recently, it’s a comfort knowing that if your area is deemed for disaster relief you can tap your 401k for necessary expenditures.

5. 55 and Separated From Service

According to the IRS, those that retire early or force out may have access to their 401k early.   This is their wording:

“Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55″

You can take a distribution from a qualified defined contribution plan, i.e. 401(k), and avoid the 10% penalty. A couple key things to note on doing this is that it must be from the 401(k), 457 or 403(b), to avoid the 10% penalty. This actually happened to my father in law as his company went through a buyout and he was offered an early retirement package at the age off 55.  We ended up taking a distribution from his 401k to have some cash on hand and then rolled the rest into his IRA.

Don’t miss this important point: DO NOT roll over to an IRA if you think you may need some money.

If you have already done a 401(k) rollover into a traditional IRA, you have already missed this opportunity. Once you hit the IRA and you take a withdrawal, you are then assessed a 10% penalty.  Rolling to an IRA might make sense later on, but until you know for sure – don’t do it.

6. Stay Equal and Periodic With 72t

Another more complex strategy – that I’m not very fond of – is the little know rule of 72(t).  Why am I not fond of it?  Because 1. it locks you in for long time and 2. it’s too complicated for most.

What is the rule 72(t)?  The rule of 72(t) states that withdrawals from your 401k have to be “substantially equal periodic payments. You must use one of the three methods that the IRS has determined and then take your payment on a set schedule for a specific time period. It is required that you take those payments for either 5 years or when you turn 59 1/2 , whichever comes later.

Example of 72(t)

Let’s say you retire at the age of 53 and you elect to do 72(t) then you must take equal payments for 7 years.  If you happen to need more money during that 7 years stretch, then you’ll have to go back and pay the 10% penalty on everything taken out to that point.   Now do you see why I’m not a big fan?

If you start later on, say 56, then you’ll have to take it for 5 years till the age of 61 even though you’ve already hit 59 1/2.

401k Penalty Free Withdrawals

As you can see, there are ways to tap your 401k penalty free.  Just make sure you follow the rules.

A lot of folks that come to be either have old 401Ks, old pensions, and now this is their primary income source, and they are trying to balance that out with social security or any other retirement income sources they may have. The question I often get from these people is, “How do I get a paycheck? How do I actually draw money from my retirement accounts?” I want to address those questions and demonstrate real quickly how that works.

If you have a pension then you know that typically you are going to get automatic deposit, maybe the first of each month, like your social security. Whenever you take a pension or 401K and you roll it to an IRA, it is that simple. You are in complete control as far as when you get that money, how often you get that money, or how frequently you get that money.

Rolling Into an IRA

Let me give you a quick example of how that might work. When a client retires and they roll their retirement accounts into an IRA, most typically we will set up an automatic distribution from the IRA into their, most typically, checking account. You can have the deposit on the first of the month. You can have the deposit on the 15th of the month. You can have the deposit on the 23rd of the each month. There is no specific day or any requirement to do so. I even have a client that also wants to have it deposited every two weeks so it mimics how it was when he was working to where he is now getting two paychecks per month. That is how simple it is to get that set up.

Do you have to have it automatically deposited in your checking account? Absolutely not. You can actually get a physical check a mailed directly to your home record. Get it in the mail, take it to the bank, deposit it, and your good to go.

Pick Up the Phone

The other method you can do is to where you can actually just call whenever you need it, and we can liquidate some investments to get you a check. We would have that mailed directly out to you, or automatically deposited in your checking account. Let me give you an example how that situation might work. I have a lot of clients that will set up that monthly distribution to go out on the first of the month, and then on top of that if they ever need some additional cash flow at some point in time during that month they can call me up and say, “Hey Jeff, I need an extra 500 bucks, extra $1000. Can you send it to me?” As long as we have a cash balance available we can send that out via ACH, and it will be in your checking account in about two or three business days. It is that simple.

Meet Mr. Banker

I tell a lot of my clients, “I am now your bank. Anytime you need money, I’m the man to call that is going to get you your funds.” That’s how simple it is. It is that simple. A lot of people don’t realize how easy that is. The only thing I do want to stress is the fact that it is so simple; don’t let that give you the freedom to think that you can just take an extra distribution whenever you need it because one of the most important things is not running out of retirement income. You don’t want to tap it too quick. I always tell my clients, “Listen, it’s your money. You’re the boss of the money. I am just the order taker. You tell me. I am just here to give you some guidance, my professional opinion. Are you depleting your retirement accounts too quickly?” That is my role as your financial planner.

I just wanted to take a quick minute to address how you set up distributions from your IRA or your retirement accounts. It is that simple. Just a few forms to sign, and you’re good to go. If you have any more questions, feel free to hit me up on the blog, goodfinancialcents.com.  Thanks for stopping by, and we will see you next time.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Transcription follows below:

Hey everybody,  this is Jeff Rose from Goodfinancialcents.com. Today I am going to talk a little bit about a common question that I get quite frequently. This question is:

Is just having a 401k enough to have a successful retirement?

It is a very good question because a lot of people wonder about, am I saving enough? Am I putting enough away to make sure I get enough to retire when I want to retire and is the 401k only thing that we need to get us by? And I would say that generally speaking that answer is no. As far as my reasoning and logic behind that is this.

401k By Itself Is Not Enough

For one reason, most people that do have a 401 k, most of you are not maxing it out. This is what I’m gathered from my several client meetings of those that have the ability to put money in a 401k.

So are you putting in $16,500 per year in that 401k? If you are, you definitely have a fighting chance and if not then most likely the 401k is not going to be enough.

Note: See 2011 401k Contribution Limits

And if you have a good company that has a good match at top of that, obviously it will make it better. For those who are not putting the maximum amount in and not having good and favorable 401k match from your employer then you definitely have to consider other means and sources of savings.

You can obviously choose between traditional or Roth IRA. Both of those are excellent tools to complement the 401k and specially if you are doing the Roth IRA and you are doing the regular 401k that gives you pre tax money and after tax money. Both those together are a good compliment.

I know for me personally as a business owner  I have a SEP IRA which is kind of like my 401k.  Over and above that I have been able to do Roth IRA and a Roth IRA conversion.  That gives me some pre tax money and after tax money as well. Nothing like having options!

It’s Nice Having Options

Between the two, having a good 401k, having a Roth IRA traditional IRA, gives you another bucket to choose from. Me personally, I am not really counting on Social Security being there for me. And if it is there, it will most likely come at a later date, say 70 when I can get it, it will probably be a reduced amount. Do not plan on it being there, and utilizing 401k and Roth IRA as an alternate or replacement for that income. Between those two, another thing I would add is saving account and investment account, utilizing other investment savings tools to have that for you at retirement.

So to answer the question, if you have a 401k and is that enough? I will say no. Make sure that you are utilizing all the other tools. For me, I like having three buckets approach. If you got a 401k, Roth IRA it is another source of retirement income that could be a saving accounts or investment account. At least have three buckets, so you can always have choices when it comes to the retirement. One bucket dump’s over is depleted; you have got other buckets to choose from. So that was my advice to you. If you have any questions, feel free to email me, contact me on the blog.

You can also see my Soldier of Finance Video below that addresses having a “Multi-Bucket Approach For a Successful Retirement”.

Transcription of above video follows below. You can find more videos on the Good Financial Cents YouTube Channel.

Today I will answer a common question I get from a lot of people. Do you have a situation, you are working somewhere, you change jobs, either decided to go somewhere else, you were laid off or you were fired. Whatever the reason, if you’ve been there for awhile you most likely participated in the 401(k) plan. Now that you have left that job and you have started your new job, you have to make a very, very important decision on what to do with that 401(k). The common question I get is this:

“Jeff, I’ve got an old 401(k). Does it make sense to roll over into an IRA.”

Depending on your situation, most likely I will say yes, but there are some instances where it could make sense to roll it into your existing 401(k), which I will address in another video. Today I want to make the case why you should at least consider rolling over the 401(k) into an IRA.

1. More Investment Options

First and foremost, you want more investment choices. Most commonly what I see in most 401(k) plans you are going to have approximately 12-15 investment choices to choose from. I have seen some bigger plans that are going to have 40, 50 or maybe even 60 investment choices, but generally that is what I see. If you take that money and roll it over into an IRA, instead of just having those 12-15 investment choices, now your just opened up to the world of all the different investment options that you have. If you want to invest into individual stock, you can do so in the IRA. Most likely, you weren’t allowed to do that in your 401(k). That also applies to other investments that you will be able to invest in too.

2. Simplify Your Life

What about the simplification of your life by the consolidation of paper and account statements. I can remember one particular case, where I had a client. We sat down and he had seven different 401(k) plans. Imagine getting seven different quarterly statements and trying to sort through it. Not only that, but also trying to keep track of the investment strategy of what is going on with those seven different 401(k) accounts. By rolling over to an IRA, and now you’re being able to consolidate into this one account and if you change jobs several times, why not consider consolidating and simplifying your life. I’m all about less paperwork. Less paperwork equals more efficiency and easier to keep track of what is going on in your financial life.

3. Control Your Income

Another aspect you want to consider rolling over into an IRA, especially if you are approaching on your retirement is being able to control your retirement income. Typically, when you take a distribution from a 401(k) plan, they are going to withhold the standard 20% tax withholdings. Once you roll over to an IRA, you have some discretion, as far as how much taxes you want to be withheld from your distributions. When it comes to retirement planning and income planning, the less that you have to pay upfront to Uncle Sam, the better.

Now, in the first year retirement, it is a little bit harder to determine what the exact tax may be, but typically after I have been working with a client for a year or so, we can kind of gauge how much taxes we need to withhold from our distributions to make sure that we have taken enough out for the end of the year.

4. RMD’s

Another consideration regarding distributions from IRAs and why you should roll over from your 401(k) is if you are approaching 70-1/2. Once you hit age 70-1/2, you have to start what’s called required minimum distributions. Within the IRA, now you have discretion, as far as what investments you want to liquidate or remove from the IRA. Maybe there is something that is not performing as far and you would like to take that or liquidate it out of the IRA. With the 401(k) and those limited investment choices, you are not going to have as much say on what gets liquidated.

Those are quickly just four reasons why I think you should consider rolling over your 401(k) into an IRA. Once again, going back to point number one, having more investment choices to me that is it. Have more choices. I compare it to going out to eat and I can go to a restaurant that has five things versus going to a 65 item buffet. Anytime I have more choices, generally I am going to be happier because depending on what mood I’m in or what is going on, I will have more options to choose from.

There are reasons for relief in some quarters since the IRS release its official 2011 regulations for 401k, 403b, and other retirement plan contribution limits. This information is renewed annually based the 2010 cost of living adjustment figures. The good news is that the cost of living adjustment (COLA) numbers have stayed the same. This makes a three year period of relative stability in contribution limits. There were some fears circulating that the limits were supposed to be lowered for 2011.

Each October the limits are re-calculated using a formula that is based on the inflation rate (which is connected to the COLA figures) in the third quarter versus the previous year’s quarter performance.

401k Contribution Limits for 2011 (Traditional and Roth)

With that said, it’s time to talk about possible affects on your 401k or other retirement plan. In other words, what is the maximum amount you can contribute in 2011? It stays at $16,500 for people aged 50 and younger. There is an additional catch-up contribution available as well. It holds at $5,500. The same limits apply to other plans, such as the 403b or the Thrift Savings Plan.

Keep in mind that your 401k maximum contribution limit is based on the combine total that you can make annually for all of your plans, regardless of whether they are standard plan configurations or Roth 401ks. The matching contributions made by your employer are not included in these final 401k contribution limits. This applies even if you contribute the maximum every year. The matches are added despite the 401k limits.

401k Maximum Contribution Limits 2010-2011

As a reminder, the above limits apply to both Traditional 401k’s and Roth 401k’s

Make Sure You’re Doing Your Part

Despite the fact that these higher limits have been available since 2009, many workers haven’t used them. Much of this can be explained by the market crash. Few people were ready to assess their 401ks in such a dismal economic environment. They chose to ignore this option. Still, employer-sponsored 401ks and IRAS remain a good form of long-term retirement investment. It’s largely a matter of compound interest, generous employer matches, and associated tax deductions. If you will use the new 2011 to plan for higher contributions, you can end up earning better retirement savings in the future.

At least, there are some reasons to consider such a move in order to better secure retirement for yourself and your family. There weren’t any changes to the rules for 401ks in 2010 and now 2011, due little to no real changes inflation rates. Other areas that may provide added incentive in 2011 have more to do with new retirement laws, particularly those that focus on Roth IRA rollovers and the like.

Such policies may provide people with options for creating better tax strategies when taxes are on the rise. It may also be of service once the Bush-era tax cuts finally expire. The sluggish performance of the economy and other forecasts suggest that inflation may remain in the 2% range for a while. What this means for 401k limits is that the rate’s generally flat growth rate will lead to a similar percentage increase in future retirement account contribution limits.

photo credit: alancleaver_2000

With the world economy on shaky ground, many people have been focusing on the financial here and now more than the financial future. This is certainly understandable as people have to be able to survive today in order to live to see tomorrow, but if at all possible, it is important to look to the financial future. After all, a bit of planning today can make for a much sunnier tomorrow. Here are a few ways to buy long-term investments without breaking the bank.

Don’t Get a Job, Get a Career

It’s a fact of life that a having a college degree is becoming increasingly more mandatory for career-seekers. Sure, there are still some positions out there that do not require a college education, but they are few and far between. In order to make money in the long run, it is necessary that you spend money on higher education now. However, there are ways to go about earning a degree without draining your bank account. The first option you may want to consider is online school. Virtual classrooms are becoming quite popular with traditional and non-traditional students. Online learning is ideal for people who work or take care of children during the day, as it usually allows you to complete assignments at your own pace. Another money-saving aspect to consider is finding a college scholarship. Schools across the country offer thousands of dollars worth of scholarship money each semester – sometimes for just being who you are. Coupled with finding affordable ways to pay for tuition, earning a degree is something that should not be passed up. It is the ultimate investment in your future.

Never Say No to Free Money

photo credit: teemow

For those who are currently employed by a company that offers 401k matching programs, be sure to take the full advantage of this benefit. While it may hurt a bit to reduce your cash flow, the 401k matching system is one of the best ways to get a return on one’s investment. There are very few occasions in life where one is offered cash for doing practically nothing – a 401k matching system is one of these occasions. So make some time to speak to your human resources rep at work and find out how to maximize this benefit. By contributing a few percentage points of your income to a 401k plan, especially one that is part of a matching system, you can make a good long-term investment without breaking the bank.

Consider Investing in an IRA

Investing in an IRA is a good way to invest a relatively small amount of money in a long-term savings plan. IRA’s have a much lower maximum allowable contributions than 401k’s. This means that one cannot invest as much money in a given year. The benefit of IRA’s, however, is that they are a good investment strategy for people who are not employed by companies that offer 401k systems. Those who are self-employed, however, can use SEP-IRA’s to invest percentages of their income, offering them the ability to invest much more on an annual basis than is allowed in traditional IRA’s.

Think of Your Car as a Long-Term Investment

Let’s face it, most people simply can’t live without a car and many families rely on owning more than one car. Sure, there are some folks who live in the middle of large cities with excellent public transportation systems, but this is not the case for most people. Buying a new car can be a real pinch for those who are trying to squirrel away some cash for a rainy day or for retirement, but it is possible to think of one’s car as an investment. When researching new car deals, don’t get taken by the bells and whistles. Do you really need multiple DVD player screens and a sound system to rival the one that you have in your house? Probably not. It is best to purchase a car from a company with a good track record of manufacturing safe and dependable vehicles. Buying a used car is an acceptable option for a lot of people, but you are never completely certain what the car’s history is in these cases. It is recommended that in order to have the piece of mind that you know where your car is coming from, and to really treat it as a long-term investment, it is better to shop around for a good deal on a new vehicle.

No matter how you plan to invest, finding a great option for your long-term investments is an important thing for most people. This will help you have the money there when you really need it.

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If, like most gainfully employed adults, you have been paying into a 401K plan, you probably know that it is a setup for your retirement. You faithfully put in your allotted percentage from each paycheck before taxation, and if you’re lucky, you have a job with a company that matches up to a certain percentage. Then, if all goes well, you continue to work until retirement age (which is to say, 59½ years old), when you have hopefully saved up enough of a nest egg to support you throughout your twilight years. Unfortunately, there are times when you must begin withdrawing money from your 401K early (due to job loss, sudden illness, early retirement, or any number of other unexpected misfortunes). Whatever the reason, withdrawing funds from a retirement account before maturation can come with a number of drawbacks, so before you do anything, you should know what you’re getting into.

Avoid Biggest Early Withdrawal Penalty

To start with, the largest early withdrawal penalty you will face (on top of the regular taxes that come with any perceived income) is the 10% additional tax. The IRS actually allows certain exemptions, such as in cases of death (when funds are doled out to beneficiaries), permanent disability, separation from employment at the age of 55 or over, excessive medical bills (over 7.5% of your adjusted gross income), and divorce settlement payments (as mandated by a qualified domestic relations order). However, these are instances in which you take out the money with no intention of returning it to the account at a later date.

If you don’t meet any of these exemptions, however, there are still ways to access your money without paying this extreme penalty (or any other penalties that may be attached).

401k Distribution Alternatives

Some 401K plans offer an alternative that is not a “withdrawal” in the strictest sense of the word. In essence, you may be able to borrow on your account. Many companies do not pay for this extra feature, but if your plan is one of the few that offer this option, there are certain restrictions. Unlike early withdrawal, the restrictions are not on what the money is being used for, but rather on when and how the funds are returned. Some employers enact their own guidelines for usage to minimize the number of employees taking advantage of the loan feature (such as limiting disbursements to payments for employee or spousal education, medical bills, down payments on a first home, or payments to avoid foreclosure). But in general, the account itself does not require the borrower to meet any qualifications pertaining to reasons for withdrawal.

401k Loan

However, in order to make it a legitimate legal loan, borrowers must pay back the amount taken out, plus interest. The interest rate may vary by plan, and they are often quite low, but it may be determined to be the prime rate at the time of withdrawal, generally plus one percent.

Additionally, there is a minimum withdrawal amount (usually in the neighborhood of $1,000) as well as a maximum (usually around 50%, but sometimes it is a specific amount of money, such as $50,000). Payments are taken out of payroll checks.

Avoid Early 401k Withdrawals if Possible

photo credit: Horia Varlan

In the long run, it behooves you to avoid withdrawing from your retirement account early if at all possible, since you will most likely be very glad to have the funds when you actually retire. And if you do end up paying penalties, you are pretty much just throwing away money that you worked hard to earn. But if you find yourself in a situation in which you have no choice but to withdraw funds from your 401K, you do have a few options to consider. None of them is precisely ideal, and you will more than likely end up paying at least income tax on any withdrawal, but you may be able to avoid additional penalties if you get all your ducks in a row.

Leon Harris writes for a Canadian financial blog with an emphasis on careers, real estate, politics, and banking. Leon is not affiliated or endorsed by LPL Financial.

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