Recently in Retirement Accounts Category

(expletive) unbelievable. Or rather, should I say, all too believable: House Democrats Contemplate Abolishing 401(k) Tax Breaks

Words fail, but I'm going to try anyway: Do you have any idea how much of a difference for the worse it will make for the economy? Do you have any idea how much it will hurt the retirements of the "working class" folks they say they are trying to help? For the economy, about the size of the mortgage meltdown bailout every year, while restricting our economic growth rate by at least a third. For the 401k, do the math with a 28% yearly drain on contributions and income within the account, and over a 40 year working lifetime, it cuts the size of the nest egg by a much larger factor than the tax rate.

It is the fact that this money currently accumulates tax deferred which is the biggest reason why it is a good investment. The company match is actually number two. Let's say you contribute $1000 per year. If you contribute multiple thousands, just multiply the results by however many times you contribute $1000. If you get an 8% compounded rate of return, this will cut the size of the nest egg from $281,000 per thousand per year, to $112,000 - sixty percent of the money just gone, and seventy percent of the actual increase in value (you would have $40,000 even if you put it in a mattress). And here's the sick part: For costing you $169,000, the government only collects $43,000 in taxes! If they just waited until you start withdrawing, at the end of your career, they'd get close to $79,000 at the same tax rate! Is this brain damaged or what?

Don't believe me? It's pretty trivial to program in the spreadsheet of your choice.

Change the assumption to a 10% rate of return (very achievable), and instead of $488,000 times however many thousands of dollars you contribute, you only have $163,000 as the multiplier, and the government only collected $63,000 in taxes, as opposed to over $136,000 if they just waited.

Admittedly, there's also Time Value of Money calculations to make, but this is just so unbelievably stupid that I had to check my calendar and the date stamp to make certain it wasn't an April Fools Day joke taken out of context. This is lose-lose-lose by any measure - unless your only criteria for "benefit" is "the government gets your money now"

Most of what you read on financial planning in the media is garbage, but here is one of those occasionally useful pieces: IRA Rollovers Could Have Tax Implications.



Here's the idea: You keep company stock in your qualified plan aside from any rollover you may do. Leave it with the company. Convert it to non-qualified money, which means you take the hit for ordinary income at whatever you paid for the stock, or its value at time of acquisition(consult a tax professional. There used to be some circumstances where you could substitute other assets of equal value, and avoid the ordinary income hit altogether). Hold them for one year or more after conversion.



Now, if you sell them, you're talking about long term capital gains, rather than ordinary income tax, a much lower rate, and subject to your control as to when you realize it.



Because it's no longer part of your IRA, you are not paying ordinary income tax rates on the whole amount as you take it out of the account. Nor is it subject to Required Minimum Distribution (RMD) rules that the IRS has. You pay only capital gains tax when and where you redeem them, as you redeem them. Capital gains is a much lower tax than ordinary income, provided you hold for at least one year.



This is not for every qualified account. Since the brand new Roth 401s are after tax accounts, the whole thing is rather self defeating if the assets should be held in one of those, or in a Roth IRA for that matter. Why would you want to do this to conserve taxes if there are no taxes due if you just do nothing?



Now, by and large, I recommend moving your money to an IRA of equivalent nature when you leave a company. Traditional 401k to Traditional IRA, Roth 401k to Roth IRA. But as you can see from this, there are exceptions to that general rule.



Caveat Emptor



(Postscript: My wife is the IRA clerk for a fairly large local institution. You would be amazed how often people get bad advice from generic tax farms, and how often theoretically competent professionals do the rollover forms wrong. This highlights the fact that just because they work for Famous Well Known Corporation, doesn't mean they know what they're talking about. Matter of fact, I've regularly seen people working for Famous Well Known Corporations give awful advice that cost clients money, and would lose the business permanently to anyone else. But people cut Famous Well Known Corporations way too much slack. It is a better strategy to consider the individuals who will be performing your services.)

Wall Street loves fear and greed. Every time some bad news hits, a lot of benighted investors sell investments that were basically solid. Causing the price they can get for their investments to drop (higher supply, lower demand). Every time a piece of unexpected good news hits, you can expect stock price to take a jump, and people rush in and pay too much for the security. Emotions: buy for too much, sell for too little, and pay transaction costs both ways. It's a recipe for tanking investments.



One of the first thing every financial text tries to teach you is dollar cost averaging, but few people learn it and apply it where it counts. If the company has solid management and it's doing well and is well positioned, chances are that them missing earnings per share targets by 7 percent for the quarter is just unimportant. It might be if it's part of a trend, but past results, or trends, rarely get reported with current ones in the financial press. Actually, you're lucky if they tell you about special charge offs influencing the result, or special one-time gains in the case of good news. Accountants can hide a lot, and make it appear to be other than it is. For these reasons as well as the above, you could do worse than to make "buy on bad news, sell on good" your investing mantra.



People get all kinds of irrational in the short term, especially about money. This is behind most of the legendary stock run-ups of the last several decades, most of which quietly slid back down after hitting a peak. As long as the reasons you thought the company was originally a good investment apply, keep on doing what you were doing.



Now I'm going to run a table of a $100 per month under two different suppositions. The first is that there is a smooth 10% annualized increase in price. The second is a small random walk (real world, prices are more volatile than this). Watch what happens over three short years.

month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

smooth increase $10.00 $10.08 $10.17 $10.25 $10.34 $10.42 $10.51 $10.60 $10.68 $10.77 $10.86 $10.95 $11.04 $11.13 $11.23 $11.32 $11.41 $11.51 $11.60 $11.70 $11.80 $11.90 $11.99 $12.09 $12.19 $12.30 $12.40 $12.50 $12.60 $12.71 $12.81 $12.92 $13.03 $13.14 $13.25 $13.35

total smooth 10.000 19.918 29.754 39.509 49.184 58.779 68.295 77.733 87.093 96.376 105.583 114.713 123.769 132.750 141.658 150.491 159.253 167.942 176.559 185.106 193.582 201.989 210.326 218.595 226.795 234.928 242.995 250.994 258.928 266.797 274.601 282.340 290.016 297.629 305.179 312.667

value smooth $100.00 $200.83 $302.50 $405.01 $508.37 $612.59 $717.67 $823.63 $930.47 $1,038.19 $1,146.81 $1,256.32 $1,366.75 $1,478.10 $1,590.36 $1,703.56 $1,817.70 $1,932.79 $2,048.83 $2,165.84 $2,283.81 $2,402.77 $2,522.71 $2,643.65 $2,765.59 $2,888.55 $3,012.52 $3,137.53 $3,263.57 $3,390.66 $3,518.80 $3,648.00 $3,778.28 $3,909.64 $4,042.09 $4,175.64

volatile price $10.00 $10.20 $9.80 $9.60 $10.50 $10.80 $10.10 $11.00 $10.70 $10.90 $11.20 $10.80 $10.60 $11.00 $11.50 $11.80 $11.00 $10.90 $11.60 $11.60 $11.90 $11.99 $11.75 $12.00 $12.40 $12.60 $12.00 $11.80 $12.40 $12.80 $13.00 $13.25 $13.00 $12.90 $13.40 $13.35

total volatile 10.000 19.804 30.008 40.425 49.948 59.208 69.109 78.200 87.545 96.720 105.648 114.908 124.342 133.432 142.128 150.603 159.694 168.868 177.489 186.109 194.513 202.853 211.364 219.697 227.761 235.698 244.031 252.506 260.570 268.383 276.075 283.622 291.315 299.067 306.529 314.020

value 100.00 202.00 294.08 388.08 524.46 639.44 698.00 860.20 936.74 1,054.25 1,183.26 1,241.00 1,318.02 1,467.76 1,634.47 1,777.11 1,756.63 1,840.66 2,058.87 2,158.87 2,314.70 2,432.21 2,483.52 2,636.36 2,824.24 2,969.79 2,928.37 2,979.57 3,231.07 3,435.30 3,588.98 3,758.00 3,787.09 3,857.96 4,107.49 4,192.17

Notice that the ending price is the same in both cases, but that under the volatile scenario, you have acquired more shares, and have therefore made more profit, by $16.53. Why? Because you bought more shares when the price was lower, and fewer when it was higher. This "weights" your good months for low prices more heavily than your bad months with high prices. Keeping in mind that you invested $3600, your profit is $592.17 instead of $575.64, that's a difference of three percent in the amount returned.



Now real world security prices are somewhat more volatile than this, and if you maintain this discipline for decades instead of years, the difference will be larger - much larger. I've seen five percent of the entire net result, as opposed to a hypothetically smooth return that ends up with the same price at the end of the period. That's the difference between $20,484.50 after ten years, and $21,508.72, and all from the same $100 per month (that would be $12,000 if you'd tucked it into a mattress).



People do the silliest things, jumping in and out of investments for short term inconsequentials. Just because they do it, though, doesn't mean you have to copy their foolishness. Indeed, having the intestinal fortitude to keep investing in a strong solid security when they hit a rough patch is one of the best times to be investing, because you're buying at depressed prices, when all those folks who panicked bucause the CEO's daughter had triplets, or similar nonsense that has negligible impact on long term performance, are selling cheap. If the reasons you were buying no longer apply, get out, but so long as they do, temporary hits to the price are a good thing when you're buying.



Caveat Emptor.

Most of what you read on financial planning in the media is garbage, but here is one of those occasionally useful pieces: IRA Rollovers Could Have Tax Implications.



Here's the idea: You keep company stock in your qualified plan aside from any rollover you may do. Leave it with the company. Convert it to non-qualified money, which means you take the hit for ordinary income at whatever you paid for the stock, or its value at time of acquisition(consult a tax professional. There used to be some circumstances where you could substitute other assets of equal value, and avoid the ordinary income hit altogether). Hold them for one year or more after conversion.



Now, if you sell them, you're talking about long term capital gains, rather than ordinary income tax, a much lower rate, and subject to your control as to when you realize it.



Because it's no longer part of your IRA, you are not paying ordinary income tax rates on the whole amount as you take it out of the account. Nor is it subject to Required Minimum Distribution (RMD) rules that the IRS has. You pay only capital gains tax when and where you redeem them, as you redeem them. Capital gains is a much lower tax than ordinary income, provided you hold for at least one year.



This is not for every qualified account. Since the brand new Roth 401s are after tax accounts, the whole thing is rather self defeating if the assets should be held in one of those, or in a Roth IRA for that matter. Why would you want to do this to conserve taxes if there are no taxes due if you just do nothing?



Now, by and large, I recommend moving your money to an IRA of equivalent nature when you leave a company. Traditional 401k to Traditional IRA, Roth 401k to Roth IRA. But as you can see from this, there are exceptions to that general rule.



Caveat Emptor



(Postscript: My wife is the IRA clerk for a fairly large local institution. You would be amazed how often people get bad advice from generic tax farms, and how often theoretically competent professionals do the rollover forms wrong. This highlights the fact that just because they work for Famous Well Known Corporation, doesn't mean they know what they're talking about. Matter of fact, I've regularly seen people working for Famous Well Known Corporations give awful advice that cost clients money, and would lose the business permanently to anyone else. But people cut Famous Well Known Corporations way too much slack. It is a better strategy to consider the individuals who will be performing your services.)