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Are 401(k)s a Financial Silver Bullet?

It’s hard to find something everybody agrees
on. Crunchy or smooth? Smooth. Mac or PC? Fries or onion rings? Fries. But if there’s one financial instrument
that seems universally beloved, it’s got to be the 401(k). Everybody loves ‘em! People delay saving for a home, building an
emergency fund, or even paying off high-interest debt in pursuit of this conquering hero: the
tall, dark, and handsome 401(k). My hero… There’s a whole lot to love with the 401(k). So saddle up and take a ride to find out what
makes this cowboy the darling of investors everywhere! The year was 1980, and The Revenue Act of
1978 was finally going into effect.

And deep in the bill was a tiny provision;
Section 401, Subsection K. Largely overlooked, Section 401(k) allowed employees to defer
taxes on bonuses and stock options — basically a way for rich executives to make more and
pay less tax on it. But everything changed in 1981 when the IRS
ruled that employees could also contribute from their SALARY. This was music to employer’s ears! Managing all those employee pensions was expensive,
complicated, and downright risky! Maybe this new fella, 401(k), could replace
the dusty old pensions of our grandpappies. Before long, 401(k) fever was spreading like
wildfire! By 1996, 401(k) accounts held over a trillion
dollars! How does it work? Fundamentally, a 401(k) is an employer-sponsored
investment account.

It lets you invest part of your paycheck and
receive a tax benefit for doing so. Like company-provided insurance programs,
you have to opt-in to participate. The most attractive feature is the “employer
match”. Translation: if you save for your future,
the boss rewards you with “free” money, matching your contribution dollar for dollar,
up to a limit. Around half of 401(k)s offer an employer
match and this “free money” can come to thousands of extra dollars! Then there’s the sweet tax breaks.

Depending on the type of 401(k), your contributions
could be “pre-tax”, meaning it lowers your taxable income for the year. OR, you can pay the tax now, and allow that
money to grow tax-free. The more you save, the less taxes you pay. Looking pretty spiffy over there, Mr. 401(k)! Oh — and don’t forget that your contributions
are being invested in stock and bond funds. We have Two Cents episodes about those if
you’re not sure how they work. Now you can just sit back and watch compound
interest fatten your herd! Free money, big tax breaks, and investment
growth! What’s not to love?! Hold your horses there, partner. While the 401(k) has a lot going for it, there
are a couple burrs under the saddle.

Like the risks of managing your own investment
portfolios instead of leaving it to the professionals. As 401(k)s soared in popularity during the
80’s and 90’s, billions of dollars flowed into risky sectors like tech-stocks. And when things came crashing down — like
they did twice in the 2000’s — many working folks were left adrift like a tumbleweed in
the wind. And did you know that “Mr 401(k)” doesn’t
work for free? A study by TD Ameritrade found that 73% of
participants didn’t know how much their 401(k) costs, while 37% weren’t aware they
were paying fees at all! Investment firms regularly rack up hefty fees
since nobody’s paying attention — with the average being around 1.4%! And remember that juicy employer “match”
we mentioned earlier? Well, that might not end up being yours thanks
to “401(k) vesting”.

Even though funds might appear in your account,
they’re only yours once you become “vested” — often 3 to 5 years after you get hired! With the vast majority of millennials only
expecting to stay in a job for a few years at the most, that’s a lot of “free money”
that never gets collected. Despite their perks, and general popularity,
401(k)s have left a societal legacy that’s, well, ugly. See, 401(k)s were originally designed to be
a supplement to worker pensions. For most of the 20th century, it was common
for workers to stay with a single employer for most of their lives. And for that loyalty, their company offered
a defined benefit pension for the worker’s golden years.

These plans offered steadiness and security,
with the employer watching over everyone’s plans — from the janitor to the CEO. By their peak in 1980, 38% of all private
sector workers had an employer pension. Today, thanks to the 401(k), only 13% of private
sector workers have a pension. And while 401(k)s have their perks, they're just not as stable or reliable. 401(k)s are also “opt-in,” which means
you aren’t automatically enrolled. Left to their own devices, many employees simply aren’t saving enough — if they’re saving at all. Of the 79% of workers eligible to save into
a 401(k), only 41% opt to participate. The National Institute on Retirement Security
finds that the median retirement savings balance is just $3,000 for all working-age households
and a mere $12,000 for those near-retirement! Most financial experts recommend a personal
retirement savings rate between 10 – 15%.

The real rates are between 1 and 3%. The 401(k) was designed to be the side-dish,
not the main course. Saddling workers with the “opportunity”
to manage their own retirements has created a national crisis in retirement preparedness. But the good news is that if you know its
place, and use it wisely, a 401(k) can be a great part of your financial toolkit. Since pensions are going the way of the horse
and buggy, you’ll need your 401(k) to be galloping double-time to keep from being left
in the dust.

Take advantage of it and you’ll be riding
into the sunset instead of off a cliff. And that’s our two cents! If you've been transitioned from a pension to a 401(k) tell us about experience in the comments!.

As found on YouTube

401K to Gold IRA Rollover

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Can You Really Retire in Your 30s?

When the Social Security Act was passed in
1935, retirement officially began at 65. And the life expectancy at the time was 58. So from the very outset, “retirement”
wasn’t exactly considered a universal experience. But over the last century as life expectancies
have climbed, the concept of retirement has become synonymous with the final chapter in
a person’s life. Then, the book “Your Money or Your Life”
came out in the 90’s and introduced a radical concept The author, Vicki Robin, proposed that by
living with extreme frugality for a few years, younger people could essentially become “retired”
long before old age. She claimed to have achieved financial independence…
in her 20’s! Today, the phenomenon of financial independence
at a young age goes by the acronym “FIRE”. It stands for “Financial Independence; Retire
Early”. And it’s no fringe movement – FIRE has been
covered by the New York Times, Market Watch, and Forbes.

And it’s got more and more millenials wondering
“could I quit my day-job too?” This isn’t about dropping out of society
or living in a cave… necessarily. FIRE practitioners work extremely hard while
living far below their means for years to amass enough savings to leave the workforce. And it doesn’t mean you’ll spend your
newfound freedom just hanging out in bowling alleys like Jeff Lebowski. Many people who manage to retire early continue
to work–but only on projects they’re passionate about. But the question remains… is it possible
to achieve through savings alone? Peter Adeney, aka “Mr. Money Mustache”,
might be considered the modern FIRE movement’s founding father. Adeney was working as a software engineer
while living dramatically below his means during his 20’s. He took his savings and paid off debt and
invested it it in stock-index funds. By 2005 and in his early-30’s, Adeney and
his wife had amassed around $600,000 and a paid-for home. He calculated he had enough to leave the work-force-permanently.

Adeney suggests that Early-Retirement is possible
through three fundamental concepts: Frugality, Investing, and the “4% Rule” of withdrawals. Let’s face it – unless you luck into a large
windfall of cash, you’ll have to save up a serious nest egg to retire. And the simplest way to do that is to slash
your lifestyle. Normally, financial advisors suggest a 10-15%
savings rate to retire at a normal age of 65 or so. Want to retire ahead of schedule? Then you’ll have to level that up. Most early-retirees adopt a 50% to 75% savings
rate… or more! It’s not uncommon for them to cut restaurants
& bars, buy cheap cars, bike to work, make do with a smaller house, and avoid luxuries
like gyms, fancy vacations, and expensive hobbies. Simply stashing cash into a bank account is
a good start. But the FIRE proponents rely on the power
of the markets to boost their savings rates. Assuming you saved your money into a general
stock-market index fund, you might expect 7-10% rate of return, based on historical

Any experienced investor will tell you that
year-to-year returns will swing wildly, maybe even crash! So that’s where the third rule comes in… A 1998 study by Trinity University concluded
that a 4% annual withdrawal rate of your money in retirement should allow you to never out-live
your money – even in a bad economy. This means that even with the dramatic ups
and downs of the stock and bond market, as long as your yearly expenses stay below 4%
of your total savings, you should be able to live off them for… well, theoretically,
forever. Put another way: you take your annual spending
needs, then multiply it by 25. That’s the amount you need to become financially
independent. By now I imagine you’re wondering what it
would take if YOU wanted to to retire early. I think it’s time to… RUN THE NUMBERS! Let’s imagine you have a household income
of $85,000, but you live way below your means and only need $35,000/yr to be happy.

According to our rule of 4%, you’ll need
$875,000 in the bank in order to be financially independent. Through extreme thrift and aggressive cost-cutting,
you’re able to save $50,000/yr, which comes to 59% of your annual income. At that rate of savings, and assuming your
stock-index funds got an average return of 7%, you’ll have hit your goal in… 12 years. A good income, frugal living, and compound
interest are a powerful wealth-building combination. You might be wondering “What if I don’t
make a ton of money? Is this realistic?” A common critique of the Early Retirement
movement is that Adeney and other leaders of the movement had high-paying jobs in medicine
or engineering. Making big bucks can certainly speed up the
process. But it’s not a requirement. Take Jillian Johnsrud. She began working towards financial independence
at age 19. Her husband served in the armed forces and
she worked in customer service and sales. Over the next 13 years they made an average
household income of $60,000, with no year over six-figures. And by 32 Jillian had saved enough to be completely
financially independent. All while raising adopted & biological children
and climbing out of $52,000 of debt. She uses her freed-up time to travel the country,
write, and raise her children.

Today she does some work as a writer and coach,
but it’s on her terms. If you think that “early retirement” is
all about lounging around and avoiding work, you’ve missed the point. Instead, it’s about taking an active step
to replace a job you hate with work you love… and often finances are the biggest hurdle. As Adeney says about the FIRE phenomenon:
“Early retirement means quitting any job you wouldn’t do for free – but then
continuing right ahead with work in something that works for you, even when you don’t
need the money.” And if you’ve already got a fulfilling job
you love– congratulations, you already have the benefits of early retirement without having
to save up for it! So whether or not you want to sprint toward
early retirement, the mindset of reducing your lifestyle, living simpler, and building
a more rewarding work-life is something we should all be aiming for. And that’s our Two Cents! If you were to retire today, what would you do with your newfound freedom? Tell us about it in the comments.

As found on YouTube


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