This Retirement Party is Coming to a Close

All good parties must come to an end, and this one is no exception. The old geezers of the group, grandma and grandpa Pension, are complaining that the music is too loud and that it’s past their bed time. They have however agreed to do one last meet and greet before this shindig wraps up. So without further ado it is my pleasure to introduce you to Mr. & Mrs. Pension (they are cranky so we will keep this short).

So what is it? Pensions are company sponsored retirement plans that provide retired employees with a fixed payout, usually paid monthly, for the remainder of their life. A common requirement is that the employee work for the sponsoring company for a specific period of time determined by the company (this is referred to as vesting) in order to qualify for the pension benefit.

How does it work? The employee first must sign up for the pension plan then complete a vesting period, usually 5-7 years of active employment, once complete they are entitled to a fixed benefit in retirement (age 65). The amount paid is usually determined by number of years worked for the company and salary level upon retirement or throughout the employee’s career. Traditionally pension plans do not require employee contributions, the employer provides all the funding, however there are some plans that may require employees to contribute.

  • Example[1]: Sam worked for Procter & Gamble for 30 years; his Pension plan states that he will be paid 2% of his average salary multiplied by the number of years worked for the company, each year once he retires. Sam’s average salary during his employment was $70k per year. To calculate his pension payment Sam multiplies 2% by his average salary ($70k) then multiplies the result by years worked (30) to get $42k (2% x $70k x 30). The result, once Sam retires he will receive $42k a year in pension benefits, or if paid monthly $3,500 a month for the rest of his life (pretty sweet deal in my opinion).

Important information to note: Over the past few decades pension plans have become scarcer, especially in the private sector mainly because of the high cost to maintain. With no employee contribution in many cases, and guaranteed befits, the employer must offset any market downturns to maintain the fixed benefits. It should be no surprise that direct contribution plans like the 401(k) have become the retirement vehicle of choice due to lower costs and the ability to pass the responsibility for retirement planning on to the individual employee.

So that about wraps it up for this retirement party, if you have any additional questions about pensions drop a comment below and I’m sure we can convince Mr. or Mrs. Pension to get back to you. If you missed all the action until now you can catch up here with the 401(k) and here with the IRA.

I hear there is an after party in the works for sometime next week, make sure to tell your friends (I hear Facebook, Twitter, and Google+ are good ways to do that ;)) so they can catch up on all the action before it happens!


[1] This is a very simple example; the math behind the real calculations can be much more complex.

It’s a Retirement Party!

I have received many requests to write a blog post on the various types of retirement plans. This isn’t surprising, since many of my friends are recent college graduates starting their first big boy (or girl) jobs and have never given retirement planning a thought. Instead of doing one long post covering every type of plan I am going to write three separate posts covering the most popular plans, the 401(k), IRA, and Pension. With that little introduction out of the way let’s kick this retirement party off with the big daddy, the traditional 401(k).

So what is it? The traditional 401(k) is a company sponsored retirement plan that allows you save for retirement by making pre-tax contributions to the plan. Not every company offers a 401(k) and you can not open one on your own, it must be through an employer.

How does it work? You elect through your employer to contribute funds to the plan on a pre-tax basis, usually a set percentage of each paycheck (for more information on pre-tax deductions check out the mini series your paycheck). The company sponsoring the plan will provide the employee with multiple options where they can choose what to invest the funds in, common investment options include, index funds, mutual funds, bond funds, and company stock. Once you retire and begin withdrawing funds, those distributions are then taxed at ordinary income taxes rates (see here for example) In many instances your company will match your contribution up to a certain percent (aka: Free Money![1]).

For example, say I make $10,000 a month (I wish!); and the company I work for will match my contribution up to 6% dollar for dollar. This means if I contribute 6% of my paycheck ($600) the company will also contribute an additional 6% ($600) for a total contribution of $1,200.

Matching varies from company to company and the terminology may differ as well. You might find out that your company matches the 1st 3% dollar for dollar then a 2nd 3% at .50 cents on the dollar, up to 6% total. This means the first 3% of your contribution is matched in its entirety and the subsequent 3% is matched at 50%. Using the $10,000 example from above an employee contribution of 6% ($600) would equate to an employer match of 4.5% ($450), the first 3% dollar for dollar equaling $300 and the second 3% .50 cents for each dollar totaling $150.

Important information to note: a 401(k) is not like a normal bank account, it is governed by different laws and regulations. The biggest difference is you can not access your money whenever you want, because it is a retirement account the money can not be accessed until you retire or reach the age of 59 and a half. Now, there are certain instances when funds can be withdrawn before retirement but you could be subject to penalties or additional taxes. Each situation is unique; if you need to withdraw money early from your 401(k) it is best to speak with your HR department or a financial advisor. There are also limits to the amount you can contribute to the plan in a given year, for 2012 the limit is $17,000 and if you are over 50 you can contribute an additional $5,500 for a total of $22,500. These limits do not include employer matching.

What’s all this noise about a Roth 401(k)? A Roth 401(k) is the same as the traditional 401(k) except for one key difference, contributions are made after tax instead of before.  When money is withdrawn in retirement there is no tax withheld since it was already paid. Now many people want to know which plan is better, Roth or Traditional, and the truth is one is not “better” than the other. The choice of which plan to choose largely comes down to your individual tax situation, weather you prefer to pay taxes now or later, and your assessment of future tax rates (something very hard to determine). If you think tax rates could be higher when you retire it may be beneficial to choose a Roth plan, if you think rates will be lower the Traditional plan may suit your needs better.

WTF does the (k) mean? The (k) refers to the sub-section of section 401 of the IRS code. Not nearly as exciting as you thought the answer would be, was it?

Next up is the Individual Retirement Account, or IRA.


[1] It’s for this very reason that if your company offers a 401(k) you should be contributing!!

Making the Offer

While home for Christmas I decided to resume my car search after a 2 month hiatus (my previous post published a few days ago was long overdue as those test drives occurred in early October). Now just because I wasn’t searching for a car that doesn’t mean I wasn’t thinking about it, I was. As my friend Chris put it so eloquently “dude, you’re the King of waffling” and you know what, he was right. I have gone back and forth on this car decision more times than I care to count. I’d wake up one day ready to rock n’ roll determined to buy a car, the next I would be telling myself “the Saturn is fine, no need to buy something you don’t need.” However, after more deliberation I decided that if I was going to make a purchase, the last week of the year was the time to make it happen.

First I started off by looking for loan pre-approvals; I checked three sources, Bank of America, BBT, and Chase. Bank of America’s process was simple enough, I filled out the online application and heard back almost instantly, they literally called 10 minutes after I hit the submit button. I was approved for a 72[1] month $16,000 loan at 4.07% not too bad, but I thought I could get better. So next was BBT, one of banks used by my parents. For this route they suggested I call and see what the rates were since I wasn’t an account holder. Ten minutes later the guy on the phone is telling me the best rate I would be approved for was 7.25%, I was shocked, but the reason was because I didn’t have a minimum five lines of credit history. That requirement surprised me as well, five lines seems to be an awful lot of credit. Regardless I only have two, my Chase Freedom Visa and Bank of America Visa. Oh well, on to Chase. I filled out the online application which was similar to Bank of America, but this time I had to wait a day for an email response. I was rejected…why? I have not a clue. I been a customer for 3+ years, paid my credit card off every month (balance is often over $1,000), and have part of my paycheck direct deposited to them. I will be investigating this further and will post what I discover. So in the end, Bank of America it was.

Now that I had financing in order I just had to find the car. I decided during my 2 month break that I wanted a BMW 328i Coupe 2007 or newer. I had been eyeing this one since before thanksgiving http://www.hillsboroautomart.com/web/used/BMW-3-Series-2008-Tampa-Florida/2139099/ it’s list price was certainly over my budget of $23,000 or $21,000 with trade-in but I figured since it had been sitting for a while, there was a good chance they would come down in price (at the time of my offer the list price was $26,976). Before driving out to Tampa to take a look I decided to do some searching near my neck of the woods so I spent an afternoon driving around the Clearwater St. Pete area looking for coupes, and ended up finding nothing I was interested in. The next morning it was off to Tampa to check it out in person. The car was just as nice as online, it was exactly what I was looking for, dark blue exterior, tan interior with wood trim, and spoke wheels. Time to take it for a test drive, upon the initial start the engine made a weird ticking sound, according the sales guy that was normal for a BMW that had been sitting for a while and would go away once driven (and it did). Music to my ears, the car had been on the lot for a few weeks now and because of this clicking I knew no one had driven it for quite some time. We took the car out and everything checked off, as I pulled back into the dealership I was ready to make an offer.

Turned out the sales guy Nick who had been helping me out up until now couldn’t talk about the offer and had to get a “numbers guy” to take over if I wanted to make one. Which looking back was unfortunate, because Nick was a great guy and had made the experience up until that point a pleasurable one. No “number guys” were available at that time so he hooked me up with the owner. At that point I was feeling really good, I found the exact car I wanted, it had been sitting for weeks, and I was about to talk to the owner who has the most wiggle room, which meant I wouldn’t have to deal with the “aww I got to check with my manager” crap, sweet! But this is where the story turns, the owner brought me into his office and proceeded to take me on a 20 minute sales pitch about how great the dealership is, how they don’t offer the antiquated financing technique of add-on loans (which I am pretty sure is not used anywhere, and is possibly illegal), he busted out the paint meter and told me they are the only dealership who uses one, told me how many vehicles they sell each month, and showed me pictures of the dealer auction of where they buy their cars. The real kicker was when took out a binder of email print outs from Gmail to show me “proof” of why a car-fax is unreliable and how every car from Miami is junk…I have no idea who would buy email print outs as proof…for all I know he could have typed them up and sent the “proof” to himself. Once we got past all this, I made my offer, which I knew was lowballing him, but I figured start low and work our way up. I offered $19,000 plus my trade in; he looked at me then got up and left the office mumbling something about being too far apart and not playing the numbers game. I sat there for a second to register what happened, then I got up and walked out. A bit flabbergasted by the utter rudeness of the owner I got in my car and left.

As I drove home I was a bit bummed that a counter offer wasn’t made. I decided I was going to give it two days and if I still wanted the car, I would call back and make a second offer. Well two days passed and I still wanted it, I called up the dealer to make my 2nd offer $23,000 no trade. The conversation was short and to the point, the “numbers guy” insisted the best they could do was $28,000 out the door. Since that was the case no deal was made. So, here I am few weeks later still driving the Saturn, but still looking for the right deal. My first car buying negotiation didn’t quite go as I expected, but hey, I learned a few things this time around and will be better prepared when I make the next offer.

Update: As of 1/15/12 I noticed the car had dropped in price to $23,976, a $3k reduction, so much for “the best we can do is $28k out the door.” I am considering putting in a third and final offer, $24,000 out the door, no trade in, what do you guys think?


[1] The reason I chose 72 months was to give myself the most flexibility in terms of the monthly payment. I don’t intend to take the full six years to pay off the loan, but if there is a month where I can only pay the bare minimum I wanted that payment to be the lowest amount possible.

Buying a Car – Test Drives (2)

See part one here

Lexus IS250 – 2008

What I liked: Overall it is a very good looking car, (if you haven’t noticed by now, a cars looks are very important to me). That it has four doors, having driven a door two for 8 years I know there are times when four would really come in handy. It had a very functional interior; many cup holders, little storage spaces, and logical layout for controls.

What I disliked: The drive was very mundane for a car that is marketed as “sporty.” Lack of power and lose steering did less than impress.

Other notes: Basically reminded me of driving a really nice Camry…

Mercedes C300 – 2008

What I liked: Not much, the Mercedes badge on the front?

What I disliked: Wow was I underwhelmed with this car, I had never driven a Mercedes, maybe rode in one once, but I expected much more. I think I have been in Fords nicer than car I test drove. Overall the car was just a let down, maybe because this is their entry level model? I could write a list of everything I disliked or just save us both the time and say see below…with that said, see below.

Other notes: Drove like…an overpriced four door sedan.

Infiniti G37 coupe – 2008

What I liked: Intuitive controls for the radio, A/C, etc, luxurious interior and kick ass factory Bose sound system. The 330hp engine and the mean growl it made when I punched it. I believe it shares its engine with the 350z, which is one of my favorite sounding cars.

What I disliked: no sunroof, breaks seemed a little weak for a car with that much power, driver seat head rest is in the way of checking for blind spots, and really small back seats. Overall the car certainly felt used, more so than the other 2008’s I drove even with only 37k miles on it. That makes me wonder if it was just the particular car I drove or if all Infinities hold up questionably over time.

Other notes: Out of all the cars I have driven so far this had the best combination of luxury, performance, and price

 

 

 

Your Paycheck – Tying it all Together

This will be my last post in the Mini Series “Your Paycheck” it will be a large example incorporating all aspects of the previous posts in this series, Gross Income vs. Net Income, Taxable Income, Federal Allowances, Federal Income Tax Withholding, State Income Tax Withholding, Before Tax Deductions, and After Tax Deductions, Enjoy!

One quick note before I start: the goal of this post is to give you a template for calculating your own net income. You may have more or less of the pre-tax deductions, allowances, etc than stated in the example below. Following this methodology and substituting your information should yield correct results and give you a detailed understanding of how your paycheck goes from gross to net income.

Jackie is married and lives in the state of Illinois, her husband currently does not work; therefore his gross income is $0, for tax purposes they plan to file jointly. Jackie’s gross income is $65,000/year, she claims two federal allowances, makes an annual contribution of $2,600 (4%) to her 401(k), has a total benefits cost of $900/year (health, vision, dental, etc), and has no post tax deductions. What is Jackie’s take home pay?

Our 1st step is to determine Jackie’s taxable income

We first need to subtract her pre-tax deductions (401(k) contribution and benefits cost) from her gross income.

Total income after pre-tax deductions is $61,500, but the example also states she claims two federal allowances, in 2011 each federal allowance claimed lowers taxable income by $3,700. We must adjust taxable income for those two allowances as seen below.

Jackie’s total taxable income is $54,100 this is the number we will use to compute federal tax withholding, reference the federal tax withholding table below. We will also use $54,100 to calculate state income tax withholding.

Since Jackie is filing jointly we will use the second column of the above withholding table. See a breakout of the calculation below. (If you need more detail on how to use this table please reference the post on Federal Income Tax Withholding).

Total Federal Withholding is $6,080, but we can’t forget to compute social security and medicare tax as well, which if you remember are based upon gross income, not taxable income.

Now that taxes on the federal level have been computed we need to figure out state income tax withholding. Illinois has a flat state income tax rate of 5% so calculating withholding is pretty straight forward, taxable income x 5%.

Jackie has no post-tax deductions, so we are now ready to add all of the components above together and compute net income.

*Semi monthly values are simply the annual amount divided by 24.

There we have it! Jackie’s net income is roughly $49,000 per year. That is drastically different from her gross income of $65,000; $16,000 lower drastic! Granted she does keep the amount contributed to her 401(K)…but this large gap emphasizes the importance of knowing what happens to your money before it hits your pocket-book. Armed with this knowledge you can better pre-pare for taxes, retirement, health benefits, and monthly budgeting.

Here is a link to the Bankrate.com tax calculator which will yield the same results as above using the sample data. Use it with your information as a double-check to your own calculations, or to take a quick look at your paycheck without having to perform all the calculations above. (Tip, “457 plan withholding” is where you input retirement plan withholding)

http://www.bankrate.com/calculators/tax-planning/401k-deduction-calculator-taxes.aspx

Hopefully you’ve enjoyed this mini series and you learned something new and informative.