Tales from the Wallet: Tax-Savvy Investments

Marc by Marc Jacobs - Turnlock Shine Long Tri-fold (Electric Teal) - Bags and Luggage Something I’ve been thinking a lot about since I read it is this Mint article on “The Value of Tax-Deferred Savings.” According to the article, “[u]nless you make enough money to max out all of your tax-advantaged accounts (401(k), IRA, 529, HSA, and the like), it rarely makes sense to do any investing outside them.”  (Please note, I am not a financial adviser — this is all just my personal knowledge, so take it with a grain of salt.) (Pictured: Marc by Marc Jacobs – Turnlock Shine Long Tri-fold (Electric Teal) – Bags and Luggage, on sale at Zappos from $198 down to $150 today. Lots of great sales on Marc by Marc Jacobs stuff on Zappos today, actually.)

To be honest, the value of tax-deferred investing isn’t something I understood until really, really recently. So I thought we’d review some of the main vehicles for tax-savvy savings here, answering — for each, the main questions on everyone’s mind:

  • What’s the advantage?
  • How much can you put into it?
  • Who can use it?
  • Can you use it to put a downpayment on a house, or pay for something else big (wedding, car, schooling, etc)?
  • When can you take it out?

Oh, and all of these vehicles aren’t the “end” of the story; you still have to figure out what fund or bond or stock you want your money to go into once it’s into that tax-deferred account.  If you don’t have time to research the different options, here’s my tip:  look for a “lifecycle” fund, such as a “Retire in 2040″ or “Retire in 2050″ fund — the idea is that the fund manager reallocates the fund over time, so right now it’ll be heavy in aggressive investments like stocks, whereas when you’re closer to retirement they’re in safer investments like bonds.  (N.B., though: I have heard that you have to really pay attention to these when you get closer to retirement to make sure they’re conservative enough for your blood.)  Where possible, I’ve linked to different articles written in plain English to back up my assertions; I’ve also linked to the non-fun IRS pages.  Oh, and note that all of these deal with earned income only — so, for example, you can’t open an IRA in your child’s name and gift him $5K to put into it every year (unless s/he has somehow earned the money — child modeling, anyone?).  And one other note: can I just say I am stunned at how hard it was to “source” this article — for example, MyMoney.gov has a whole page on “saving for retirement” with “helpful” advice such as “don’t eat out a lot,” but next to no information on IRAs.  Thanks, government!

401K

  • What’s the tax advantage? Money goes in before it is taxed, and grows tax-free.  Even though the money will be taxed when you take it out, the idea is that your tax rate will be much lower when you are at retirement age.  Furthermore, because it grows tax-free, you’ll save thousands of dollars over the long run.  Very noteworthy bonus:  many employers “match” — if you put in $3,000, they put in $3,000.  Everyone agrees that if you don’t at least contribute up to the match, you are throwing away free money. That said, I have never had the pleasure of working for an employer who matched.
  • How much? If you’re under 50, as of 2012 the maximum you can contribute every year is $17,000.
  • Who?  You have to contribute to your 401K through your employer — so if you aren’t a permanent employee, you’re out of luck.
  • Can you use it to put a downpayment on a house? No.  This is the big drawback to 401Ks — instead of being able to use the money for something right now (house, wedding, car, school), it is Retirement Money.  Sometimes you can take a 401k loan out, but that can be tricky.
  • When can you take it out? Age 59 and a half.  If you take it out before age 59.5, you will pay income tax as well as an additional 10% early distribution penalty tax (although there are some fun exceptions, such as disability or death).

Roth IRA

  • What’s the tax advantage? The money you put into a Roth IRA comes after it’s already been taxed — but you don’t pay taxes on it once you withdraw it.  Furthermore, the money grows tax-free over the years. Technically, this is tax-exempt saving rather than tax-deferred saving.
  • How much? You can put $5,000 into a Roth IRA and/or a traditional IRA every year.
  • Who? You can only contribute to a Roth IRA if your adjusted gross income is below $125,000 (for singletons) or $183,000 if you’re married and filing jointly. (See also.Note that unlike other vehicles, there are no mandatory withdrawals at age 70.5 — and you can continue contributing to it for as long as you are working.
  • Can you use it to put a downpayment on a house? After you’ve held the account for 5 years, you can withdraw up to $10K in earnings without penalty or tax for the purchase, repair, or remodel of a first home. (See also.)  As readers have noted, you can always withdraw principal.
  • When can you take it out? While there are some exceptions (such as first time home buyer, significant unreimbursed medical expenses, etc), the normal age at which you can take it out is at 59.5.

Traditional IRA

  • What’s the tax advantage? Like a 401K, money placed in these accounts grow tax-deferred.
  • How much? For 2012, you can contribute up to $5K annually.
  • Who? You can contribute to a traditional IRA even if you participate in an employer-sponsored 401k. Note, however, that if you or your spouse is covered by an employer retirement plan such as a 401K, that will affect how much of your contribution is tax-deductible.  Depending on your income, you may only be able to take a partial deduction (if you make between $56-$66K and you’re single, or $90K-$110K if you’re married filing jointly), or no deduction at all if you make more than those amounts.
  • Can you use it to put a downpayment on a house?  You can withdraw $10K for the purchase of a first home without paying the 10% penalty tax.
  • When can you take it out? 59.5, generally.  If you are under age 59.5, you must pay a 10% additional tax on the distribution of any assets (in addition to any regular income tax) unless you meet some of the exceptions, such as for higher education or the purchase of a first home ($10K limit, though).

I’ll take a look at other investment vehicles (such as 529s and HSAs) in a later post (update: Part II is here).  Oh, and Forbes just had an interesting article on a “back-door Roth” strategy, noting that if you make too much for a Roth IRA but have the cash to save, you can open a traditional IRA and then go to the trouble of converting it to a Roth IRA, where it can grow tax-free.

Readers, how much are you saving for retirement each year (versus saving for specific events such as a wedding or the purchase of your first home) — and which of these vehicles are your favorites?

 

Comments

  1. What a helpful post.
    I have recently increased my retirement contribution (still only 7%, I’d like to work up to 10%), but it’s amazing what a difference a few pre-tax percentage points makes. When I started working, I randomly checked off 3% because I was nervous about budgetting and wanted to buy lots of shoes (joking!) and what a mistake. My SO who started working at around the same time started off with 7% and when I saw how much is in his retirement fund 3 years later vs. mine, I was stunned.

    • I ratcheted up to 15% for a few years in order to save for a down payment on a house (which we borrowed from our 401Ks, and I now understand that is a bad idea.) My husband moved to saving 15% just one year later than me. When we bought the house three years later, 3/4 of the down payment came from my 401K. The miracle of compounding. :)

    • I increase my contribution each time I receive a merit or COLA by half the percentage of the increase. For example, my cost of living adjustment was 3% this year so I increased my 401K contribution by 1.5%. I make sure I put in for the contribution increase before it hits my paycheck. I still see the slight bump in pay, but never miss the extra contribution to my 401K. This is a great way to slowly work up to maxing out your contribution limit without feeling it in your paycheck!

      • Lizzie, that is a great way to go and I hope others will consider it. If you get a 2% raise, put 1% into your 401K. If you do this for just a few years, you’ll be at the max, and quite painlessly.

  2. Great topic. I utilize all three types of accounts although i can no longer contribute to the Roth.

    two notes:
    1) If you’re looking to get the full employer match on your 401(k) – and why wouldn’t you? – you need to spread your contributions out evenly over the year. typically best done as a deduction from each of your paychecks. so don’t let’s say, take your tax refund money and pump it into your 401 (k) in april, and then not contribute the rest of the year.
    2) Everyone needs to form their own opinion on this but for a starter (or even an expert) investment I really think a simple no-fee low-expense-ratio index fund is better than a lifecycle fund, which, if nothing else, typically carries higher expense ratios.

    • Agree on the low fee index fund. I also think if you’re diversifying your 401K portfolio, don’t forget to place some of your investments in bonds or even money markets. As 2008 reminded us, the stock market is not guaranteed to rise! The rule of thumb I’ve heard is that your age is the percentage you should place in non-equity investments. Last, diversify your equity holdings to some percentage international funds, not just US.

      • agreed. and you can actually do all of this diversifying with index funds, which exist for all kinds of assets – stocks, bonds, domestic, int’l, smallcap largecap and everything in between.

    • I would like to hear others’ opinions about regular v. lifecycle index funds. I did lifecycle, but not for any particular reason, and now I am getting nervous that I need to reassess.

      • My 401K is in a lifecycle account. I honestly haven’t compared the expense cost of the lifecycle vs an index fund. I know my 401k offers index funds, but honestly, for me, the lifecycle is the easiest to forget about. And in 35 years when I actually need it, I will be there for me.

      • Anastasia :

        YMMV depending on your age, risk tolerance, how much time you’re willing to put into research, and the funds available in your 401k plan. I am under 28, and I am willing to accept risk at this point in my life, so I go by the general rule “subtract your age from 100, and that’s the average percentage that should be in stocks.” It’s almost as easy as a lifecycle fund, but I can pick index funds with lower expense ratios. I check once a year, rebalance as necessary, and then forget about it again.

        I have about 75% of my 401k index funds — large medium and small cap, and international (20% each of the first 3 and 15% international). To pick them, I went through my 401k offerings and highlighted the expense ratios of each fund, and picked the lowest in each of those categories. The other 25-30% is in a couple of bond funds, again “diversified” and picked primarily based on expense ratios.

        • DH and I each max out 401(k) & ROTHs, and have a few other accounts. I do a lifecycle in my 401(k), and it’s done well even in this recession because it’s largely index funds. No managed fund ever beats the market decades in a row, but they can do well for about a decade due to risk. For example, my ROTH did wonderfully 1998-2007, but since 2007 it’s been miserable due to 25% stock turnover — the money managers is trying to make his salary (higher expense ratio) in these low growth years and the risks aren’t panning out for investors. Definitely do your research and choose how much risk you feel like you can take on, and remember how the investing house is paid.

    • I am an ERISA attorney. The DOL has indicated that life cycle funds are appropriate QDIAs (default investments) for those participants who did not select an investment. Essentially, choosing a life cycle fund is a safe harbor.

      However, there is a small contingency of ERISA lawyers who believe that if an employer chooses a life cycle fund as a QDIA that it is actually breaching its fiduciary duties to employees. Life cycle funds tend to have relatively high fees. Also, they are relatively new investment products and it is unclear that they are going to out perform the appropriate index funds.

      The one advantage to a life cycle fund is that you can invest and forget about it. The idea behind a life cycle fund is that risk will be limited as you near retirement. So, if you are the type of person who will not approriately reallocate your investment mix every 10 years or so, then you may be better off in a life cycle fund (despite the higher fees).

    • A note on fact #1 – I believe this is highly dependent on your employer’s policies / processes around matching. I max out my 401(k) by the end of the first quarter every year and always receive the full match. This is because my employer looks at my total contributions at the end of the year and processes the match once.

  3. Great post. Any advice out there for self-employed/contractor/1099 folks?

    • I have a SEP-IRA through Vanguard — not too hard to set up at all.

      • Diana Barry :

        Ditto, my DH has one through Schwab. The limits are higher on them (if you have a higher income).

        • Thanks, Kat and Diana. I max out a Roth IRA every year, but am now ready to open another self-funded retirement account where I can save more than the Roth IRA limits. A SEP-IRA looks like the easiest option right now.

  4. Threadjack alert!

    I just wanted to vent a little today if that’s all right. I just found out that on the one hand, I scored the big interview (a whole half day of meeting with bigwigs and the search committee!) for my dream job. I’m off to get a new suit to prepare!

    On the other hand, I also found out that I’ve lost the “custody battle” with my ex of 3 1/2 years over our cat. It’s amazing how much people can change after a relationship; he put his foot down and told me I could never see the cat again. I’ve decided that as much as I love the cat, it’s not worth the continued battle with someone who’s been jerking me around so much. I know it seems silly– custody battling over a cat?– but it really hurt. I’m only proud that I’ve kept my cool and not let forth the “choice words” I have for how he’s treated me and this situation. I wouldn’t wish immature exes on anyone!

    Back to the good: any tips on how to nail the dream interview? I’ve been on many interviews before, but nothing on this scale. For reference, it’s at a university, and I’m in the communications field.

    • Consider it all good news. Not that you won’t miss your cat, but the fighting is over and you’ve got a clean start on both fronts.

      My only interview advice is pretty generic. Research the university and the role and the recent communications stories that have come out about it. Write out what they are likely to ask you and practice answering each of those questions in front of a mirror or in front of a friend. Make a list of the 5 things you want to make sure they know about you when the interview is over, and figure out how to work that in as well. Get a great night’s sleep. Arrive early. Drink water/use the bathroom well in advance. Smile.

      Good luck!

      My

      • Thank you very much– it is definitely a clean start, and though it’s painful, it’s a necessary step, I think.

        I hadn’t heard advice about a list of things you want them to know about you– wonderful! Thanks for the encouragement.

    • First of all, sorry to hear about the cat. I used to joke with my ex-husband that he could leave but the cat would stay. Despite the fact that he had had the cat since he was a kitten, he had quickly become my baby. That sweet boy had died by the time we split, and our split of the two cats we had (who hated one another) was easy. As you say, you should be proud of yourself. This kind of thing is never easy.

      As for your interview, you say you’re in the communications field, but I’m assuming this is IA, not a teaching position. Those jobs are different from any others in the university. They dress much more conservatively and present a much more public face. Looking polished, excellent communication skills, excellent examples of materials produced, and the ability to connect with people with be very important. Good luck!

      • Thank you for the kind words. I’m glad I’m not the only one that’s had difficulties over pets. I’m glad to hear yours was accomplished with as minimal pain as possible.

        It is a staff position, and luckily, I used to work with several people I’ll be interviewing with. Thanks for the good wishes, I’m very optimistic!

    • I worked at a university for 10 years in various roles before finishing my degree and moving into law. If you can find out who you will be meting with google them to see what they have published or classes they have taught or even where they went to school. Use linked in, etc. I know there is a delicate balance between coming off as a creeper and coming across as prepared. I know some universities have profiles of their staff/administrators/professors (etc) because they like to show off and you can use that to build connections with people. Some departments have their own webpage and you can use that to gain information about what they do and good questions to ask. My university was notoriously slow at getting back to candidates afterwards, so I would ask when they plan on making a decision.

      Good Luck! (sorry about your cat!)

    • Interview Prep :

      I am in-house counsel for a university and deal with our communications folks a lot.

      I am sure you have already, but I would read:

      * local, national, international press about the campus over the last year
      * speeches or other posts by the president/chancellor about the mission
      * collateral about the university generated by the communications office
      * if you can find it online (we are public so ours is online) the name/mark usage policy and guidelines

      Good luck!

    • Good luck! :

      Hope it goes well for you.

  5. Equity's Darling :

    Sigh, sometimes the tales from the wallet posts make me wish there was a Canadian corporette.

    Regardless, for the Canadian corporettes, here are some links to the CRA’s website and our equivalents:

    RRSPs (tax-deferred)
    General: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/menu-eng.html
    Homebuyer’s plan: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/menu-eng.html
    Lifelong Learning Plan: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/llp-reep/menu-eng.html

    TFSAs (tax-exempt)
    http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html

  6. Threadjack, but it's about money :

    DH and I are looking to go to my parents’ for Easter. I am in charge of getting plane tickets. Two weeks ago, they were $300 (twice as high as I think they should be). Last week, they were $175, but DH was noncommittal so I didn’t buy. Today they are $250. Questions: (1) Do I buy now before prices go up, or wait until next week (Tuesday I hear is a good day) and see if they go down? (2) Is there something reliable and akin to shoppingnotes that will alert me when flight prices go down? I found something like this on farecompare, but I’m not sure whether it’s reliable or scammy.

    [Apologies if this comes up elsewhere -- I tried to post before, but I think my comment got swallowed. I also mentioned, in the spirit of staying on topic, that it really isn't that hard to covert a regular IRA to a Roth, and this is coming from someone who is bad at money and bad at computers. I also have a Roth 401(k). This way, my taxes are taken care of now -- when I know (1) what they are and (2) that I can afford them.]

    • try farecast.com which, as its title suggests, forecasts airfare trends for specific itineraries.

      • Lourine P :

        You should always buy now because the present value of money is not that much, especially given the zero rate of interest paid out by banks. It will be better to have the tickets in hand now than to wait and risk getting frozen out or worse, getting the seats by the honey can.

    • You can also set an alert on kayak and they will send you an email every day with the fares so you won’t miss a good deal. I believe that they have a fare forecaster as well.

    • bing.com / travel also has a “fare predictor” that shows whether ticket prices have been trending upwards, downwards, or holding steady.

      • Geneticist :

        farecast = bing.com fare predictor (Microsoft bought Farecast)

        Farecompare is legit as is Kayak, but neither of them can track Southwest (Southwest doesn’t let “fare aggregators” republish their fares) and certain other tiny airlines.

        I personally think Kayak is not as useful as farecompare and airfarewatchdog because Kayak only sends emails 1x a day and for major hot fare sales, the fares might only last an hour or so.

    • The cheapest day to buy is normally Tuesday. Wednesday is second-cheapest.

      WSJ had an article on this recently:
      http://online.wsj.com/article/SB10001424052748704062604576105953506930800.html

  7. I agree with maxing out your 401K first, but that’s mainly due to employer matching.

    I’m not convinced that tax rates will be lower when I’m retired. I realize it depends on how much I withdraw every year, but my deductions will certainly be lower, as (I hope and pray) I will no longer have a mortgage at that point.

    • Kat left off another option–the Roth 401(k). I contribute 100% of my retirement savings into a Roth 401(k). Taking the tax bite now hurts, but I am basically going all-in on a bet that tax rates will skyrocket before I retire. (If I could go even more than all-in, I would. Have you seen the tax rates people had to pay before 1986? And our current deficit?)

      The Roth 401(k) is just like what it sounds. It is a 401(k) account that allows you to pre-pay the tax, just like a Roth account. Since it is a 401(k), you are eligible for any match that your employer offers and aren’t subject to the income phase-outs like you would be in a Roth IRA.

    • My husband and I diversify our tax risk. I contribute to a traditional 401(k), and he contributes to a Roth 401(k). Not only does this diversify tax risk, but using a traditional 401(k) also helps to lower our current tax rate potentially and allows me to max out my 401(k) and have more take home now.

    • Anyone else wish there were no AGI limit on who can contribute to a Roth IRA? I make more than the limit, but not much more. And I agree that tax rates will be much higher when I retire than they are now. But I am stuck with a traditional IRA and a traditional 401(k) — actually 403(b) and 457(b) (I have both because I work at a public university, and I max them both).

      • Another S :

        Can you use the backdoor Roth strategy?

        And while we’re on the subject of backdoor Roths, can someone explain the pro rata rule for calculating tax rate when converting contributions to a traditional IRA into a Roth IRA? I’ve tried to research it and found explanations/examples but for some reason none of them are “clicking” with me.

      • Anastasia :

        Yes. I have a pretty decent amount in my Roth IRA (yay for starting early!) but I bumped myself over the Roth limit last year, and now I need to figure out how this backdoor strategy works. And I probably need to hire an accountant just to make sure I don’t f it up the first time, because that pro rata calculation isn’t “clicking” for me either.

        The good thing is, when you are over 55 (I think) the AGI limits go away. My dad was recently very psyched about this.

  8. Kat, should NOT we be worried about the web’s databreach/hijacking of our information on Zappo’s?

    http://lakeridge.patch.com/articles/what-the-zappos-data-breach-means-to-you

    I think the ladies in the HIVE want to know.

    When I asked the manageing partner about this, he gave me this hypolink.

  9. I was just thinking this morning that I needed to research retirement funds and start contributing, so this is perfect timing. Seeing it all laid out like this makes it very clear what we need to be doing.

  10. Interested in the HSA post when it comes. I’m maxing mine out (spouse and I each carry our own health insurance, only my insurance plan qualifies for HSA contributions) but I don’t view it as an investment vehicle, perhaps because paying out of pocket for prescriptions, doctors visits, minor procedures, etc. actually ate through everything in my first year of having one.

    • I thought my HSA was practically empty, but I bought new glasses on Monday and paid for them entirely with my HSA debit card.

  11. Snarky In House :

    Speaking of ShoppingNOtes… I had never heard about it until the last few days and I’m intrigued… does someone want to give me their referral info so when I sign up you get something?

  12. I love the Tales from the Wallet series!

    I max out my 401k (no match), and my husband just recently switched to doing the same (partial match). We’re debating what our next savings/investment vehicle is going to be. We need to first build up our emergency fund, but following that we will probably contribute to my existing IRA from a previous job and/or start funding a general brokerage account. I’m not sure if the IRA regulations are worth it, since we don’t currently get any tax benefit from it.

    Money related threadjack – DH has stock as part of his deferred compensation that is roughly equivalent to our credit card debt. We are tempted to sell it and pay off the debt. We expect that the stock will not appreciate at a rate higher than our credit card interest rates, and it will take us roughly the same time period to either pay down the debt with cash or pay ourselves back for the value of the stock. At this point we’re inclined to sell it and pay ourselves back, but is there anything we should be thinking about (aside from the tax implications)?

    • We did this with my husband’s stock. Every time he came home and said “The stock hit a new high today” we would sell a big chunk and pay off debt. We didn’t time the peaks perfectly, but by selling when the stock was up, we made out very well. (Some of his colleagues, not so much because they held theirs and really stressed when the stock would get low.) Sell high, buy low. Sounds so simple, but that is what you need to do to win in the market.

      BUT, I think you should keep some stock. We held onto the last $1,000 worth. We’re not selling it anytime soon. Our thought is, what if his company becomes the next Microsoft or Apple, and we dumped all of our shares before it really took off? Obviously we would regret having sold what we did, but at least we would still have a small stake in things. (Right now, it looks like that will not happen because the stock has gone down, but one can dream.)

    • Assuming your credit card’s interest rate is in the healthy double digits, I agree that the stock is probably not going to grow that fast. My question would be, are you allowed to sell it? Lots of times the stock comes with restrictions, e.g. stock options on a set timeframe, restricted stock units, etc. so not simple to liquidate. If you do sell it just watch out for tax implications (as you note) and brokerage fees.

    • I’ve heard over and over that if you’re paid partially in stock, you should make sure to sell some/most of it (and presumably reinvest in something else – in your case, invest in paying down the debt), b/c if the company tanks at some point, you might end up out of a job AND the stock would be worthless. Just another way of diversifying, really.

    • Thanks, everyone! And just to answer a few questions:

      @ Homestar – we would be keeping some of the stock (he has also purchased some through an employee purchase program that we do not intend to sell), for the ‘what if’ element as well.

      @ anon – we believe the restrictions on the portion that we would be selling will have ended by then (the stock will have vested, and I don’t think there are any requirements about holding the stock for an even longer portion of time).

  13. Just wondering, do your employers match? If so, are they big law? I’m in big law and they don’t match. I wasn’t sure if that was typical of the industry.

    • Anonymous :

      Yes. In-house counsel, Fortune 1000. Match up to 5%.

    • MissJackson :

      BigLaw generally has no match. My firm actually did match until about 5 years ago, but we were one of the last hold outs, I think.

    • Snarky In House :

      The company I’m leaving (an atty in house) is a smallish company and did not match when I started. Then they completely did away with the plan b/c very few people participated.

      The company I am going to (close to 1,000 employees) has a match of up to the first 6% that you contribute. So, I guess I’ll be starting my first ever 401k soon!!

    • I work in biglaw. There is no matching for attorneys, but there is for staff.

    • I’ve never heard of a BigLaw that matches for attorneys, including my former employer (as well as those of my friends). Although many match for staff.

      I don’t know anything about 401k law, but I’ve been told not matching has something to do with the employer has to pay a tax/fee if too many high earners participate in the 401k, but not enough low earners….how’s that “explanation” for vague. I’m sure someone around here can explain why Biglaw doesn’t match for lawyers.

      • karenpadi :

        This. There is a “safe harbor” though. I think that’s why my firm does something with 3% (I don’t know if it’s a match or if it’s based on/part of our salaries). This year, we received a “bonus” that no one was counting on directly into our 401k. It’s nice that they care about our retirement but I’d rather have had the ability to make my own decision about the money.

      • I can’t speak to Biglaw specifically, but here in MediumLawsville, we match. However, when you’re a shareholder, the matching basically comes out of your overhead.

        So I might be oversimplifying, but there might be a very simple explanation, and it might be greed.

    • I know of one Big Law that has profit sharing (somewhat similar to a match). Generally, it is difficult for Big Law to match because of the IRS’s anti-discrimination rules.

      • I was in MediumLaw, and while that firm did not match (for associates, counsel or staff), it did have a profit-sharing plan for counsel and for staff. This was “free money” contributed by the firm directly to our 401(k)s. I have no idea how the amount was technically calculated (obviously it was based on the firm’s profits for that year), but it varied every year, and had no relationship to the amount we had contributed. One of the many things that made me say, “Why didn’t I do this years ago?” re: moving from associate-partner track to of counsel voluntarily.

    • Yes, 100% match of the first $300, 50% match up to 3%, plus another 5% regardless of whether you contribute or not. Large non-profit.

    • Mid-Law here. Employer does match for both staff and attorneys (but not until after you’ve been with the firm for a year) – first 1% is matched at 100% and the next 5% are matched at 50%.

      • Small-law here. My firm doesn’t match, but contributes a flat 3% of my annual compensation regardless of what I put in. I’m working up to maxing out (one more adjustment should do it), but it’s nice knowing that I’m not leaving any match money on the table by not maxing out yet.

    • Praxidike :

      Yes. In-house counsel. They pay 50% of the first 6% of salary deferred as a match.

  14. MissJackson :

    One note: you do not have to wait 5 years to withdraw principle (as opposed to earnings) from a Roth IRA — you can withdraw principle at any time. This is the biggest advantage of the Roth IRA, in my opinion. It’s a little extra “emergency” money.

    Thanks for this article. I’ve been considering doing a back door Roth IRA conversion for awhile, and should probably do so this year.

    • Roth Conversion :

      Dear Miss Jackson,

      I did a conversion last year. For two years before that, I put post-tax money (the max allowed) into a traditional IRA. Then last year when you could convert no matter what your AGI is, I converted. I am paying the conversion tax over two years.

      BEWARE: calculating the conversion tax is very tricky. It depends in large part on the value of all your IRA accounts, not just the amount you convert. I had thought that because I was converting post-tax money, there would be no tax. Not so much. I converted about $15,000, and the tax is about $4,000. The only way I (a not-math inclined person at all) can understand it is that the government is cranky that it won’t get the tax on that money later when I take it out, so it wants to get its pound of flesh now. Maybe someone more math-inclined has more insight?

      All that said, I still think it was a smart move for me to get money into a Roth IRA because I’m pretty sure that taxes when I retire in 20-25 years are going to be very high.

      • MissJackson :

        Thanks. I think that what you described is the pro-rata rule, which is implicated when you have additional IRA funds that will not be converted.

        Right now I have no IRA at all (my retirement account is entirely 401k — part Roth, part traditional) — but I could open one before April 17 for 2011 and fund it to the full $5k with post-tax dollars, and then immediately convert into Roth, and (if I’m not missing something), I would not have an additional tax bill. My understanding is that I would be unaffected by the pro-rata rule because I have no other IRA funds to “pro-rate”.

        I assume that a back-door conversion Roth IRA has the same withdrawal rules as any other Roth IRA — i.e., that I can withdraw contributions at any time without penalty. Can anyone confirm? I have sufficient cash on hand to fund an IRA for conversion for myself and my husband now, but part of it is my “emergency fund” so I wouldn’t want to put it somewhere that I couldn’t get to in case of emergency.

        • Another S :

          I believe the conversion must happen during the calendar year; you don’t have until April 15 of the following year like you do with a typical IRA contribution.

          • Another S :

            One more comment: I don’t think the pro rata rule is implicated when one has additional IRA funds that will not be converted. I think it is implicated when once has pre-tax money in one’s traditional IRA in addition to post-tax money? (Please, someone correct me if this is inaccurate!) Also, it’s not just your traditional IRAs that the IRS looks at. When you convert a traditional IRA to a Roth IRA, it’s deemed to have come from all your traditional, SEP, and SIMPLE IRAs proportionally when you calculate how much of the conversion is taxable.

            And, @Roth Conversion, I *think * this would mean that if you converted all of your traditional IRA funds last year and want to/can use the backdoor Roth strategy again this year, you won’t be taxed on the conversion because your basis (nondeductible IRA contributions – your after tax funds) will be equal to the total value of all your traditional IRA funds. Or, at least, that’s what my financial adviser told me (that, if the rules don’t change, I won’t be taxed on a conversion in 2013 if I convert all my traditional IRA funds ($ from up to and including 2011 plus my $5K contribution for 2012) in 2012 then leave my traditional IRA account open with a zero balance until 2013). But your circumstances may be very different than mine!

          • MissJackson :

            You’re totally right on when the pro rata rule is implicated. I’ve simplified it in my mind (because the simplified version works for my very specific circumstances wherein I have no traditional, SEP, or SIMPLE IRAs and therefore have no pre-tax money in IRAs at all), but what you’ve said is technically correct to the best of my understanding.

  15. I think this is one of those things where you really need to assess things for yourself and do the math. My husband is working now (military) and I’m staying home with our daughter. Since I reassessed our haphazard investment strategy and took over that bit of financial management, we save about 25% of our income; I’m really proud of that.

    However, we don’t put anything into the alternative to 401Ks the military provides; they don’t match it at all, we don’t get to choose which funds we use from a small handful, and when I did the math on tax-deferred savings like that it just didn’t make a lot of sense for us to use it. The tax percentage benefit would have been a couple percent but come at the cost of controlling how we invested that money. On the other hand, we’ve been religiously maxing out our Roth IRAs for years and I think this is a great idea; even in lean years when you’re unable to save as much as you want or your discretionary savings are going towards a big-ticket item like a house, car, education, whatever, it’s a pot of money that stays separate from those that are easier to touch, and between two people the $10k probably won’t be the percentage you should be saving, but it may keep you away from the cat food in your old age.

    The other steps I’ve taken to save have been applying any increase in money we get – any time my husband gets a raise or bonus, instead of going into our checkbook it immediately gets added to the automatic withdrawals that are transferred to our investment accounts.

    • Do you save 25% (WOW!) of gross or net? I started saving 20% of gross recently, but I always wonder if it’s supposed to be net.

      Also, do you use USAA? Don’t you love them? I am so grateful that my dad served and I am allowed to use them.

      • I meant to post as “FOR AZ.”

      • Not the OP, but I sincerely hope it’s supposed to be net, as that’s what I do. With my salary level, I couldn’t do gross without compromising the cushion in my checking account.

        But I’m about to start really, really trying to save more than my current 20% of net, since I just had to do some pretty serious work on my car and will have to raid my emergency fund in order to avoid paying interest on the credit card balance :\ I keep telling myself to take deep breaths, and that this is exactly the reason why I HAVE an emergency fund…still, I HATE having to pull money out of it.

      • We save around 25% of gross. Most of this after our Roth IRA contributions goes into a non-tax advantaged investment account, though, because I’m not convinced a traditional IRA is a great idea. So it’s more like “general savings” than “retirement savings” – we might use it to eventually buy a house, although for now that doesn’t make financial sense to do (we move often). If my husband stays in the military for a few more years, we’ll have GI bill tuition benefits for my daughter and her potential future sibling, and he’ll have a nice pension, assuming the government doesn’t go back on its promises! So our big dream right now is for him to retire from the military, take a year off to travel around the world, and then have him (maybe both of us) look for another job after that. It’s not the most financially sensible dream, but watching one of our parents pass away right after retirement has made us realize we don’t necessarily want to wait to take some time off and enjoy life. We need to be saving at a good clip to make that a reasonable option, though.

        It’s been pretty painless to do, though it helps that we have few expenses that are truly fixed. (I personally think home ownership as investment is not all that great of an idea, but I may yet be proven wrong) Like I said, it’s mostly two things: husband’s annual bonus goes straight into savings, and every time he gets a pay bump that extra gets saved as well. On top of that, we make annual maxed Roth IRA contributions with whatever’s in the checking account. Seeing a low checking balance usually tricks us into paring down unnecessary spending a bit in late winter, but after the spending orgy of the holidays I welcome it.

        In summary, what I’ve found is that if you can live below your means, sometimes it takes psychological trickery to make sure you actually do. And yes, I’ve found USAA’s asset management accounts to be very helpful in all this!

      • Vet here – I LOVE USAA! It’s strange to love a bank.

  16. According to my financial guru, you should contribute to an IRA even if you can’t deduct or defer. Most people never take out all the money they squirreled away in IRAs and retirement accounts. By putting money in an IRA, you can avoid paying taxes on income that will be part of your estate down the road.

    • This was intriguing to me, so I looked it up online.. Aren’t you just passing on the tax burden to your heirs, then? This makes sense if you have a reasonable expectation that they’ll be paying a lower tax rate than you are, but hard to predict.

  17. I chose regular IRA over Roth, for now. Although I agree that tax rates will likely go up, we assessed it and when we took away our expenses/retirement savings/education costs/mortgage and looked at what we really needed to live, we only need about $35K actual income a year to live very, very comfortably. (I mean, that other stuff takes up about $80K a year, so there you go). So while tax rates might go up, I don’t imagine taking out more than $50K (adjusted for then) to live on when I retire, and think my particular tax rate will end up being lower than it is now, when we’re making six figures.

    Anyone else have thoughts on this issue?

    • karenpadi :

      These were my thoughts exactly. There was a period where anyone could convert an IRA to a Roth. It would have meant a big tax bill immediately and I didn’t want to risk my liquidity. I know mandatory withdrawals might affect my taxes later but I doubt I’ll be withdrawing from my IRA at the same income bracket (also 6 figures) that I make now.

      My current retirement plan is to pay off the house and either use it as rental income or live nearly rent-free (property tax).

  18. karenpadi :

    I’d add that it’s very important to keep track of 401k accounts when changing jobs. 401k fundss can be “rolled over” without a tax penalty. I’ve found that rolling over my 401k into an IRA is the easiest way to keep track of those funds. Plus, I chose a low-fee brokerage (Vanguard) and I’m saving a lot of money on fees. It’s pretty easy to do–I’ve never needed a tax guy or accountant to do it for me.

    My current employer has an awful 401k scheme. I don’t know how they manage to lose so much money in such a conservative fund. Anyone else think of formally “quitting” for a day just to rollover funds?

    • I don’t know how to answer your second question, although my previous job did have a pretty crap 401K. They matched awesomely (7% of my salary no matter what I put in) but the 401K funds had high fees. So I essentially put in a very small amount (maybe 2% of my salary) and then put the rest in….

      Vanguard! Love them. They helped me roll a previous 401K into… something that didn’t give me a tax penalty (a Roth? an IRA?) and they were SO helpful. Basically I called the number on the Vanguard website and a very nice woman talked me through my options and then we conferenced in the manager of the 401K I was moving, incomprehensible financial babble ensured, and voila! My 401K was moved.

      I sound terrible to be so clueless. I really need to improve my knowledge about investments. One thing I do have going for me is that I save about 25% of my salary in various options (federal employee TSP, Vanguard account, plain old cash account for when I decide to buy a place) so money is being saved and my investments are diversified. But I should learn more.

  19. Ladies, have any of you completely switched areas of the law that you practice in?

    I’m currently in a field of law that is just is not interesting to me at all. I do litigation although since I’m a new associate, I’m not doing anything on my own. I was hoping that when I got to the two year point I could switch into another area of law that I find more interesting. Has anyone done this? Is it even feasible? Did I just force myself to stay in this area of law by taking the job after law school in the first place?

    • No advice, but I’d also love to hear everyone’s thoughts on this.

    • I’ve switched twice, both times gradually and both times at (different) small firms. I started at a small firm doing general litigation. I had a few family cases, and over time I started seeking more and more of those until that became a significant proportion of my caseload.

      I had always been interested in immigration, and when my current firm was looking to hire, they were looking for someone who already had knowledge of family law (and an interest in continuing to practice in this area) as well as learning immigration. It was a perfect fit for me.

      So now, I practice mainly immigration (my third practice area since leaving law school), as well as maintaining a small family law caseload.

    • SouthernLegal :

      I have. I started out doing domestic law/bankruptcy, then changed to plaintiff’s work (with a variety of specialized practice areas in between), now to a more broad-based general litigation practice with much more defense work. A litigation background will give you some good practical experience which is pretty transferable among practice areas, at least in my experience. It’s what has allowed me to transition relatively easily from practice area to practice area. However, you are still very, very new. Litigation in my early years of practice was not very fun or exciting to me, at least until I became more mid-level and was able to participate in the strategy/long-term planning and execution of the cases I worked on. You may find that given another couple of years, you actually like what you’re doing. On the other hand, if you believe litigation really isn’t the area you want to be in, you can start laying the ground work for a move, even with this economy. All of the same suggestions for getting a new position apply – go to CLEs and networking events in your favored practice area, learn about that area on your own time and perhaps write an article about some area of the practice, contact local alumni who practice in that area, etc. Depending on your firm, if other members in the firm practice in the area you want, try to cultivate them as mentors, and let them know of your eagerness to assist on their cases. Switching to a new practice area doesn’t always happen quickly, but it is definitely possible.

    • It’s definitely feasible but may depend on your firm. At my BigLaw firm, no one really begins specializing until year 3 or 4, so it’s pretty easy to switch around. However, it’s definitely easier to switch within litigation than switching from litigation to corporate, although it can be done. But if you are at a smaller firm, it might be more regimented.

      If you know that you are not interested in the work, can you talk to someone NOW about switching? Why wait until year 2?

      • I’m at a small firm and would have to leave my firm to switch areas of law. I figured a solid 2 years looked better for the resume than bailing before then.

    • Snarky In House :

      I’m not at (nor have I ever been at) a firm but FWIW I’m doing that now. I’m going from one industry to a COMPLETELY different industry which is HIGHLY regulated and will have to learn a totally different set of regs/laws etc.

    • associate :

      I switched areas of litigation at the one-year mark. That was feasible because I still had transferable skills but didn’t miss out on much time in the new area. If absolutely know you want to switch, just do it. Don’t wait for the magic two year mark.

    • After 10 years in general business litigation (which itself followed two years of clerking for a federal trial court), I finished my LL.M. in tax law (having done evening coursework for 1-2 years) and now am an estate planning, trust and probate attorney. I am much, much happier — but don’t earn nearly as much as I did as a litigator, because I am still building my practice.

      My general belief is that it is much easier to switch practice areas within litigation or from primarily defense-side work to plaintiffs’ side work than to switch from litigation to corporate or vice versa. (That’s one of the main reasons I decided it was worth it to get the LL.M. credential.) Could you try out several different litigation practice areas in the next year or two (taking on some pro bono work or other volunteer work if necessary) to see whether another focus area fits you better? Securities litigation is very different from real estate litigation is very different from family law is very different from criminal law is very different from immigration law is very different from trust litigation, etc., etc., etc.

      • I am in the process of trying to switch from criminal to civil litigation and its really difficult. Not only am I coming up against an anti public service bias, but I have been told multiple times that my trial experience (which is extensive) doesn’t count because it was in the criminal arena. And the few firms that handle some criminal work act like superior court practice isn’t relevant. Soooo frustrated!

        • Yikes, I’m sorry to hear that. My thoughts on this particular type of transition may be out of whack because my mentor at my civil litigation firm started out in criminal defense (not PD, though). I also came across both civil and criminal litigators (at all levels, and well-respected) within my Inn of Court. Maybe think about doing a two-stage move — first try to focus on white-collar criminal litigation and then try to get more and more securities litigation work on the civil side?

    • Like Amy H., I practiced general business litigation before switching to estate planning and probate. I wanted to make the switch after 2 years of practice but I wasn’t having any luck getting a job due to my lack of experience in that area so I scheduled informational interviews with several attorneys practicing estate planning to ask for advice. I would recommend doing that to see what other areas interest you and to see what it would take to make the transition. Plus it is a good networking exercise as well. Good luck!

  20. Threadjack, about love :

    This is probably a long shot but here goes: I have a very pretty and sweet Indian Muslim girlfriend looking to get set up with a Muslim guy. She’s in her mid 30s, never married, highly educated professional, lives on the east coast but is very open to relocation. She’s a fantastic catch. I’m not Muslim and don’t know any Muslim guys I can set her up with.

    Anyone know of any educational Muslim professional men in their mid 30s – early 40s? If so, please email me at wingwoman51 at yahoo dot com

    Thanks!

    • I empathize with your friend and hope she finds someone great.
      That said I think there are very specific sites and services out there that serve this niche.

      • Threadjack, about love :

        Thanks for your note. Believe me, she’s tried those sites and is still on them. Trying to think of other options as well.

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