Read Suze Orman's Action Plan Online
Authors: Suze Orman
Suze Orman's Action Plan (11 page)
ACTION:
Don’t do it. Too many people these days are making this huge mistake. I understand that you are desperate to hang on to your house and will do anything to avoid foreclosure, but I definitely do not want you to take a withdrawal. You will pay income tax and may also be hit with a 10% penalty for money taken out before you are 59½. And then, six months later, you will find yourself back in the same hole: All the money from your 401(k) will be gone and once again you will fall behind on your mortgage.
A 401(k) loan carries a ton of risk too. If you are laid off, you typically must pay back the loan within a few months. So if you take out the loan, get laid off, and can’t pay the money back ASAP, you will run into another tax problem: The loan is treated as a withdrawal and you’ll be stuck paying tax—and possibly a 10% early-withdrawal penalty. A loan is also dangerous because the markets may rally during the time you have taken out the loan, which means you will have missed an important period to recoup some of your losses.
It’s also important to know that money you have in a 401(k) or IRA is protected if you ever
have to file for bankruptcy. You get to keep that money no matter what.
My preference is that you scour every part of your financial life to find other income sources for covering your mortgage. See “Action Plan: Spending” for advice on how to squeeze more savings out of your current income.
SITUATION:
Your credit card account was closed down and your interest rate on the remaining balance was increased to 32%. You want to take a 401(k) loan to wipe out the credit card debt.
ACTION:
As noted above, it is just too risky to take out a loan from your 401(k). I understand the damage a 32% credit card interest rate can do, but I want you to resist the temptation to raid your 401(k). Please review “Action Plan: Spending” for my advice on how to seriously tackle your expenses to find savings you can then put toward important financial goals, such as paying off high-rate credit card debt.
SITUATION:
You’ve been laid off and don’t know what to do with your 401(k).
ACTION:
Whenever you leave a job—voluntarily or not—you have a few options for how to deal with your 401(k). If you have at least $5,000 in your account, you can leave it right where it is.
That, however, only makes sense if you have a great plan that offers great low-cost funds. If that isn’t the case, I recommend you do a direct rollover into an IRA. Your money is transferred from the 401(k) into an IRA at a discount brokerage or low-cost fund family you choose. The advantage of a rollover is that you are no longer limited to your plan’s lineup of funds. Once you move the money into an IRA you can choose to invest in the best low-cost mutual funds and exchange-traded funds, individual stocks, and/or bonds.
You
determine your allocation strategy. You can stick with the allocation you had in your 401(k) and roll over your money into funds, ETFs, and bonds that will re-create that mix. Or, if you weren’t really following a diversified allocation strategy with your old 401(k), this is your chance to get it right.
If you are uncomfortable putting all your money into the market in one lump sum, then you can start by moving your 401(k) into a money market when you do the IRA rollover. Then from that pot you can dollar cost average: each month put one-twelfth of your money to work in the funds and ETFs you have chosen. It’s a smart way to ease your money into the markets over time, thereby reducing the risk of investing 100% at the highest prices. But if you already had your money well diversified in your 401(k), there’s no need to dollar cost average; I would just stay on the same path by
rolling your money into the IRA following the exact same allocation strategy you were using with the 401(k).
Follow my rollover tips:
Never touch the money yourself
. Make sure it is a direct rollover in which your 401(k) administrator sends the money directly to the company handling your new account. If you serve as the personal go-between, you can trigger an ugly tax situation.- Consider converting to a Roth when you roll over
. Beginning in 2010 there is no longer an income limit on who is eligible to convert a traditional IRA into a Roth IRA. You know I think Roth IRAs are the way to go for most people; the prospect of tax-free withdrawals is compelling, especially when you consider the likelihood that we are facing higher tax rates to deal with our federal debt. When you roll over a traditional 401(k) into an IRA, you can choose to move it into a Roth IRA. (You can do this in one step: You do not need to first roll over into a traditional IRA and then convert.) Now, the one catch is that you will owe tax on the amount converted. You should consider converting only if you have money to pay for the conversion. Both Fidelity and Vanguard have easy online conversion calculators that can help you get a handle on the tax cost of converting and the potential
payoff down the line. I also recommend you consult a CPA if you are considering this move. - Never do a cash-out. It is true that when you leave a job you also have the option of cashing out the value of your 401(k). That is absolutely the worst thing you can do—do you hear me? I want you to leave the money invested for your retirement—whether you keep it in the 401(k) or roll it over into an IRA. Those are your only options. Please resist the temptation to raid your retirement today. If you do that, you are jeopardizing your retirement security years from now.
SITUATION:
You have been laid off and need the money in your 401(k). Can you withdraw it without paying the 10% penalty?
ACTION:
Yes, if you are 55 years of age or older in the year you were laid off. You will, however, still have to pay ordinary income tax on what you withdraw. I want to be clear: I am not recommending that you take money out of your retirement accounts at such a young age, but I want you to understand your options if you find yourself in a very tough situation. Please do everything you can to avoid tapping your retirement money today. Using your savings before you retire should only be considered as a last resort.
SITUATION:
You are under 55 in the year you were laid off. You desperately need the money in your retirement account just to make ends meet. Is there a way you can withdraw it without having to pay the 10% penalty?
ACTION:
Yes. But it is tricky. Look into setting up a withdrawal plan that allows you to take out substantial and equal periodic payments (SEPP) from your retirement account without paying the 10% penalty. Please check with your tax advisor so he or she can tell you exactly how it works—it is covered by Rule 72t in the IRS code—and make sure your advisor is an expert in this area, because it is very complicated. This applies to all kinds of retirement accounts, not just 401(k)s and 403(b)s as the situation above does. And I need to repeat what I said above: Taking money out of your retirement account at an early age is obviously not ideal. So please do everything possible to leave your retirement money untouched.
SITUATION:
You aren’t working, but you still want to contribute to a Roth IRA.
ACTION:
You typically must have earned income to be eligible to contribute to an IRA. The only exception is if you are married and not working but your spouse works. If that is the case, then you
can make an IRA contribution through what is known as a spousal IRA: As long as your spouse has earned income that is at least equal to your IRA contribution, you are able to make the retirement investment. For example, if your spouse has at least $10,000 in earned income, you both can contribute $5,000 in 2010 to your IRAs (the maximum allowed for individuals below the age of 50; anyone 50 or older may contribute $6,000). If you are not married and have no income, you can’t contribute to an IRA.
SITUATION:
If I do an IRA rollover and then get another job with a company that has a great 401(k), can I put the money back into the 401(k) from the IRA rollover so it’s all in one place?
ACTION:
You’ll need to check with your employer to see if they’ll allow this, but even so, I have to tell you I think it’s a bad idea. As I explain above, an IRA generally affords you greater flexibility to choose the best low-cost investments; even great company plans restrict you to a limited array of options.
SITUATION:
You are worried that your company may go bankrupt and that you will lose all the money in your 401(k).
ACTION:
Confirm that your money was sent from your employer to your 401(k) plan and you have
nothing to worry about. Money you invest in a 401(k) is your money, not your employer’s. Your employer hires a third party—typically a brokerage, fund company, or insurance company—to run the 401(k), and that company in turn segregates your money in a separate account that is all yours; even if that brokerage or fund company got into trouble.
SITUATION:
You have employer matching contributions that are not fully vested and you are concerned that you may lose this money if your company goes bankrupt.
ACTION:
That could indeed happen. Money that is not vested is not yet yours. So in the event your company goes under, it is not legally obligated to leave the unvested portion of your match in your account. The money
you
contribute to your 401(k) is always 100% yours.
SITUATION:
Your employer has suspended making matching contributions to your 401(k). Should you keep up your contributions?
ACTION:
Because you are not going to get the matching contribution, you want to be strategic about how best to use your money. If you don’t have an eight-month emergency savings fund in pace, or you have credit card debt to pay off, suspend your 401(k) contributions so you have more
money in your paycheck to put toward these two important financial goals. If you have no credit card debt and you have an eight-month emergency fund, then I suggest you suspend your 401(k) contributions and instead—if you qualify—invest in a Roth IRA account. If you don’t qualify, invest in a traditional IRA. If you already have funded your Roth or IRA, then just keep taking that extra money to pay down the mortgage on your home if you plan to stay in that home forever or keep contributing to your 401(k); even without the company match, it remains a smart way to save tax-deferred for your retirement.
SITUATION:
You have money in an old employer’s 401(k) and wonder if you should leave it where it is, transfer it to your new employer’s plan, or do an IRA rollover.
ACTION:
Do an IRA rollover. Rather than be restricted to the handful of mutual funds offered in your 401(k), you get to pick the funds, exchange-traded funds (ETFs), and stocks or individual bonds to invest in when you do an IRA rollover. That puts you in total control and allows you to choose the best low-cost investments for your retirement money.