The latest Yahoo Finance article on retirement, courtesy of TheStreet, is one in which they discuss managing two 401(k)s when both members of a marriage are working. The article itself is merely an extension on the discussion of one’s own diversification in a single 401(k) but I think there are some points that it could’ve made but didn’t.

Here are some points it did make that are worth noting:

• Some 401(k)s have better funds for different things. For example, a small cap fund in one 401(k) may have a better expense ratio than the small cap fund in the other 401(k).
• One 401(k) may offer options not available in another fund, such as emerging market funds. This would allow you to have some diversification by way of emerging markets through one 401(k) and then balancing that out in the other 401(k).
• If your total retirement contributions won’t max out both 401(k), max out the one that’s more beneficial to your family. Go for the ones with better employer contributions, better funds, etc.

Some points that it missed:

• Having two funds makes management much easier, you can have one account focus on one asset type (preferably the one with better fees) and then re-balance with the other. For example, put all of the funds in one 401(k) into large cap equities and then use the other 401(k) to go international and emerging markets.
• Two accounts means greater discussion, talking about retirement and money is always a good thing.

###

MoneyNing did a fine job on the Carnival of Personal Finance this week and My Retirement Blog was included with our post Retirement fund or emergency fund?

In all the discussion about retirement plans, pensions, 401(k)s, IRAs, you may have heard the term “defined-benefit” and “defined-contribution” plan thrown around and wondered what they meant. Both are employer-sponsored retirement plan types but have slight different characteristics.

Defined-Benefit Plan
A defined benefit plan, often called a “qualified benefit plan” or “non-qualified benefit plan,” is an employer sponsored retirement plan where an employee’s benefits are calculated based on an equation using employee factors, such as one’s salary history and length of employment. Under these plans, all the management functions of the plan are handled by the company and they alone bear the risk of their decisions; employees simply get paid out according to the schedule of the agreement.

(In the case of qualified benefit plans, the qualified refer to tax-qualified and the difference is that those plans have added tax incentives. Non-qualified benefit plans do not get these tax incentives)

Pensions are a common form of defined-benefit plan. Many pension equations include a growth rate tied to the results of the investments decisions made by the plan, but if the decisions result in negative results you will often see companies dip into earnings to fund pension shortfalls.

Defined-Contribution Plan
Whereas a defined benefit plan defines the benefit an employee receives, through a calculated equation, a defined-contribution plan only defines the front side of that equation. It’s an employer sponsored plan in which a specified amount or percentage is set aside for an employee. In these plans, the investment decisions may or may not rest in the hands of employees.

401(k) and 403(b) plans are common forms of defined-contribution plan. With a 401(k), your employer agrees to match your contributions up to a certain amount or simply contribute a percentage of your salary each year. In the case of many 401(k)s and 403(b)s, investment decisions and risks are for the employee to make and bear.

401(k)’s are a great retirement investment vehicle. The two primary benefits of a 401(k) is that your employer will often give you some sort of small percentage match on your contribution and you get an immediate tax deduction for the amount you contribute. When your employer kicks in an employer match, that’s like automatic appreciation. To leave that on the table would be a huge mistake. The immediate tax deduction is also a plus because it softens the blow of not being able to access the funds and it’s a “reward” for thinking of the future.

There is just one huge problem with 401(k)’s: you are always taxed the short term capital gains rate.

Let me illustrate with an example. If you purchase a share of MRB Enterprises at $10 a share and it appreciates to $20 a share within a week, you may consider selling it. If you sell it within a week, the gains are taxed at the short term capital gains rate (your marginal tax rate). If MRB Enterprises stays at $20 for another year (51 weeks and a day), then you qualify for long term capital gains tax rates which are 10% or 15%, depending on your marginal tax rate. The difference between short term and long term capital gains can be staggering (the maximum individual income tax rate is 35%).

When you take disbursements from a 401(k), you’re taxed at your marginal tax rate no matter what. If you held an index fund within your account for the last forty years and start taking disbursements, you will be taxed not by the long term capital gains rate but instead by your short term capital gains rate.

I’m not mentioning this because I think it’s unfair, it’s totally fair; but it’s food for thought.

I’m a fan of flexibility and I like having my options as wide open as possible. That’s why I don’t like rolling over a 401(k) into another 401(k).

After leaving my first job, I immediately rolled my 401(k) into a Vanguard mutual fund account. I felt that Vanguard would give me plenty of options while keeping my costs low. If you elect for electronic delivery of prospectuses and statements, you will pay little to nothing in administration fees. With the costs low from the fee perspective, I felt I had enough options to choose from in the funds department (and they are cheap!).

What happens if you roll it over into a new employer’s 401(k)? You have a smaller subset of options (some plan administrators are larger brokerages like T. Rowe Price), higher fees, and your money is essentially trapped there until you leave your job and roll it over again.

So, before you roll your 401(k) into yet another 401(k), think carefully about it… you might find a better option.

When you leave a job, you will be confronted with a decision. If you had a 401k, you will have to decide whether you will keep it with the current plan administrator, roll it over into your new employer (if they offer a 401k), roll it over into a Traditional IRA, or cash it out. Each has its benefits and drawbacks but ultimately the worst of them all, in terms of long term sustainability, has to be the cash it out option.

If you cash out your 401k, not only are the taxes due immediately but you also take a 10% penalty. So, if you had $10,000 and are in the 25% tax bracket, you will only get $6,500 of your hard earned money. That’s right, of the $10,000 you rightfully earned, you will get only $6,500 of it!

But I’m in a tight financial situation! If you are in a tight financial situation, see if you can simply borrow from the 401k or qualify for a penalty free withdrawal. Borrowing is only allowed if your plan administrator allows it, please check with them for the specifics. Penalty free withdrawals are decided by the IRS and they cover situations where you become disabled, have significant medical expenses (expenses exceeding 7.5% of your AGI), have been ordered by the courts to pay up money, etc. You can find a list by doing a simple google search on 401k withdrawals.

Don’t accidentally cash out! If you decide to roll your 401k over into a Traditional IRA, you have two options. The first is a “trustee to trustee rollover” (or “direct rollover”) where the check is written directly to the new administrator. The second is where the check is made out to you and you have 30 days to deposit it into the new plan’s account. I always go with the first option. You never know what will happen and so you never want to tempt yourself with that kind of money. Life happens and you don’t want to have to deal with any issues that result.

Retirement is precious, don’t screw it up! The process is easy as long as you follow some simple rules, don’t screw it up by getting greedy and cashing out. Paying someone 10% to get your own money is ridiculous.

On my mainstream personal finance blog, Blueprint for Financial Prosperity, I penned an article today called How To Become A Millionaire (In 6 Easy Steps!) that begins with a two steps focused solely on retirement. For the retirement saving savvy out there, these two steps are obvious and a staple of retirement planning. Step 1 is to contribute to your company’s 401(k) plan and, hopefully, get yourself a nice employer match for your efforts. Step 2 involves contributing towards a Roth IRA so that you can diversify your tax profile, a little of tax-deferred to go with your tax-free retirement investments.

Becoming a millionaire isn’t difficult but it does require discipline. It’s extremely difficult to take some of your hard earned money and lock it up in a time capsule you won’t open for twenty, thirty, or forty years. It’s even harder if you have current financial demands such as children, bills, etc that are vying for your next dollar. If you have the discipline to do it, you should be handsomely rewarded with a more fulfilling retirement.

Many working Americans don’t have access to a 401(k). I don’t mean their employer doesn’t offer them any matching funds, I mean they flat out do not have the ability to contribute funds to a 401(k). Many of these employers are either too small, too disorganized, or otherwise find itself unable to stand up a 401(k) plan and sign up with an administrator. Whatever the reason, this leaves one of the greatest tools for retirement planning unavailable to many Americans so Yahoo Finance took it upon themselves to outline some alternatives to the 401(k) for our 401(k)-less brethren.

The number one answer to this question is that you should start contributing to an IRA. The difficulty here is that if the Roth and Traditional IRA share a single limit of $5,000. If you contribute $5,000 to a Roth, then you can’t contribute that to a Traditional IRA. You can split up your contributions, $2,500 each, but that is significantly less than the $15,500 limit 401(k) contributors can take advantage of.

The number two answer is to appeal to your employer and ask if they could look into standing up a 401(k) plan. Outside of the traditional IRA, there is simply no other alternative. There are 401(k)-like retirement plans but ultimately any employer with a significant number of employees should consider this huge benefit.

In an ideal world, you would have enough money to fund both your retirement and everything else in your life. However, in reality, you often have to make decisions because your income rarely, if ever, satisfies every single need you have. For a lot of working Americans, the decision sometimes comes down to something you need soon, perhaps a home, and something you won’t realize for many years, such as retirement. Let me outline an approach I used to save for my retirement and come up with funds for an immediate need. In my case, the immediate need was some down payment funds for a home.

What it comes down to is priority and the immediate priority is a down payment for a home so many people just cut off retirement savings. I recommend that you reduce your retirement savings to the bare minimum and then focus on your other goal. In my case, I dropped my 401(k) contributions to the minimum that would ensure I received the company match. From there, I decided that contributing the full $4,000 (at the time, now it’s $5,000) limit for my Roth IRA was going to be important as well. I predicted that one day, hopefully, my income would exceed the contribution limits so I should get my contributions in while I still could.

So, I was able to save up some money for a down payment on a home and ratchet down my retirement contributions without, hopefully, causing much long term harm.

An AP article stated that many retirement investors had begun moving their money out of the stock market, something I see as a huge mistake. This is a big mistake when you’re talking long term, which most retirement investors are, because over the long run the market will give you solid returns if you let it. By selling during a fall you’re just as likely to miss any rebounds. For example, yesterday’s pre-market indicators would make you expect the market would fall 500 points at the opening bell. However, the Fed jumped in, slashed rates by 75 basis points, and the market opened down only 200. Then, in the afternoon, bargain hunters snatched up cheap stocks and the Dow ended up nearly 300 points. That all happened in ONE day. The stock market is a volatile beast, don’t try to time it and definitely don’t try to time it in something like a retirement account!

The game plan for a retirement account is slow and steady wins the race. You can’t realize any appreciation until retirement, so don’t go trying to play the stock market game. Slow and steady, don’t break the game plan!

With all the turmoil in the stock market lately, you may be tempted to stop contributions or adjust them from your original plan - don’t! The thoughts going through your mind are typical, especially in times of crisis, but this when you should be staying the course or even increasing your contributions. Many of the fundamentals about your investments have not changed, it’s merely the public’s perception (and reaction) that has affected the share price of many companies and it presents a great opportunity to buy.

You may not remember it but the last time we had this type of panic was back in 2001 when the dot-com bubble burst and the stock market went into a free fall. A mere five or six years later, the stock market recovered and people were speaking of prosperity as if it would never end. Five or six years is nothing in a retirement plan when your horizon is ten, twenty, or even forty years out, so you shouldn’t be at all concerned. Here are a few other reasons why you should keep investing:

401(k) employer match: If your employer matches a part of your contribution, make sure you put enough to get the maximum. That represents an automatic appreciation that puts you ahead of where you were before the contribution and something that you should always do.

Long run appreciation: It’s hard to see red on the ticker but if you consider that you won’t have access to the funds for a decade or more, you can play the waiting game until those stocks or funds turn it around.

Immediate tax benefits: Every dollar you contribute is one fewer dollar you need to pay taxes on, so you might as well contribute what you can and save it for your retirement.

We’re in a bumpy patch right now with the stock market but things will turn around, they always will. If they never turn around, the last thing you need to worry about is whether you have enough money.