AskDong

I was very excited this past week to have made my first contribution to my Roth 401K.   At first I wasn’t sure if I wanted to dedicate all my contributions toward the Roth.   By contributing to the Roth 401K rather than a standard 401K, I’m effectively trading taxes tomorrow for taxes today.

I don’t have a view per se on what taxes will be for me when I retire versus what they are now.   Will taxes be higher?  Will I be in a higher income tax bracket?  Those are all questions that I cannot answer with any certainty.   However, the advantage of the Roth is exactly because of those uncertanties.

I compare the Roth 401K/Regular 401K debate to fixed rate mortgage versus an adjustable rate mortgage.  A fixed rate mortgage is not inherently better, but it gives price certainty.  That’s exactly what the Roth 401K does, it give me price certainty on what I pay in taxes.    

I max out what I contribute and as result I don’t have to make any tradeoff when it comes to how much I can contribute.   If anything because the amount I can contribute to either a Roth or Regular 401K is the same nominal amount (15,500),  I can effectively contribute more to the tax sheltered account as I pay in after tax dollars.  The one group of people who I think might be better off contributing to a standard 401K are those who cannot afford to contribute to get the full company match.  

Let’s say for example say I make $100, and my marginal tax rate is 25%, and my budget is $70.  I would be able to contribute $5 or 5% towards a Roth 401K.   Let’s also say my company matches the 1st 6% of my salary in terms of contribution.    By contributing to the Roth 401K, I would fail to max out my company match.   However if instead chose to contribute 6% towards a regular 401K, I would still be left with $71.25 in take home pay, and receive the full company match.

I really liked your saving priority list. I found it very helpful and have a
saved it to my desktop as a reminder. In addition, I have had two questions
I’ve been meaning to ask you.

QUESTION 1
I recently heard about credit cards offering a percentage back towards funding
529 plans. Fidelity offers one that give 1.5% back. I am interested in this
type of card but wanted to know (1) can I fund a 529 account for children that
are not yet born? Perhaps I put the fund in my name till I have children? (2)
Is there a card that you recommend? (3) Can I still claim a tax credit for
contributions made to the 529 via the credit card?

QUESTION 2
Have you used mint.com? What are your thoughts about the utility of this
website?

-m

I’ll answer the 2nd question first because it’s more straightforward.  Yes.   I do use Mint, but not that much.  I’m still more of a fan of Yodlee as it has better overall coverage.   What Mint offers is a simpler view, and pitches of money saving alternatives.   For some individuals the offers are useful, but not me.  Generally speaking, I’ve already done my shopping when it comes to accounts.  The simplified view is nice, and I would be more apt to use if I were just starting with account aggregation.

In truth however, I’m looking at PageOnce.   PageOnce offers a very similar service to Mint, but like Yodlee is much  comprehensive.  In addition, PageOnce also offers an iPhone App.

529 Accounts

Yes, you can still can claim the tax (state) credit even if it’s funded from you Credit Card. I don’t believe the source of funding matters.  For the tax deduction it has to be a state sponsored plan for your state of Virginia.  I don’t believe Fidelity runs any of those plans, so it’s unclear in reality how you would be able to fund the 529 plan with a credit card.

While you cannot sponsor a 529 plan in the name of child that yet to be born, you can sponsor a plan under the name of another relative, and switch the plan’s beneficiary at another date.  The age of whom can be named beneficiary vary’s state by state.

There is a common predicament that many people find themselves I’m. Save money or pay off debt. While this question can be coolly answered by crunching the numbers, it’s not really a question that that cool cold numbers can answer. This like many other financial questions is one that is really about precedent and emotion rather than the numbers.

Like most people I have debt. Luckily, my debt is good debt. Mortgages and student loans. However I am very aware that many people are burdened by not so good debt. Credit cards and even worse- pay day loans. These loans often sport egregious interest rates. Crunching the numbers almost always will tell you to pay that kind of debt first.

It’s a much easier argument to make that I should invest excess money instead of paying off either my mortgage or my student loans. The interest rates on those are less than 5.5% without even considering any tax advantages. There’s no guarantee that I could do better in the “Market,” but there’s a good chance that I can - just not these last few months. However, when you’re paying 20% on a credit card, it’s highly unlikely that you can earn any kind of return close to what you’re paying let alone beat that.

So why would you ever sock money away into a emergency fund, or into a savings account when you have credit card debt? I actually think for many people it does make sense, maybe not logical sense, but emotional sense. Just as studies have shown that people would be better off being auto-enrolled into 401ks, I believe the sooner someone is able to enroll into a savings plan the better off they are. The key is creating a savings, mutual fund, or brokerage account and turning the spigot a half turn. The savings should be more symbolic than anything else. It wouldn’t make sense to save $1000 a month and then making the minimum payment on the credit card payment. But for someone is doing a good job paying off the credit card in excess of the minimum, it can make sense to stash $25 away a month toward an emergency fund.

I often preach about having a financial plan, a budget, and goals.  However, I realize having a plan is much easier said than done, and while many of us have goals, knowing what we want isn’t always enough.  Most of us struggle with debt, or have hard time putting money toward our savings.  It’s easy for me to get on my high horse and tell others to spend less than they earn, but in truth it’s much harder said than done.  While I’ve never had issues with credit card debt, I did for years after college spend pretty much everything I earned.  I would often think about coming up with a financial plan, but I never did.

I didn’t really have much of plan until a few years ago at which point I was actually in pretty good shape.  Being able to sit down and formulate a plan is great, but if paralysis by analysis prevents you from doing anything then it’s better to move forward without any kind of set plan.  That’s what I did.  I didn’t set any goals or ask myself what I wanted to do with my financial life. I just turned the screws. I increased my contributions to my 401k from 10% to 15%, and I opened an ING Savings account and started diverting an additional 10% a month in sync with the direct deposit from my paycheck towards that ING account.  Those two items took me about a half hour to do.  5 minutes to change my 401k contribution rate, and 25 minutes to open and set up an automatic savings plan for the ING account.  I diverted 15% (or closer 13% of after tax income), but that number will vary for everyone.  Whatever that number is, it should be doable.  There is nothing worse than being overly ambitious and failing.  As a quick rule of thumb, I would divert 20% of your gross income left over after housing and debt.  So for example let’s say you paid 30% towards housing and another 20% towards student loans, that would leave you with an “excess” income of 50%.  I would suggest diverting an additional 10% towards automatic savings. Just make sure whatever that number is passes your gut check and is more than few coffees.  Take that money and do one of the following.

Increase contributions or open up a 401k

• Set up a savings account and make automatic deposits. I use HSBC and ING.  There are banks with better rates but those two have been around the longest, and offer a stable platform to launch your savings empire.  You can always chase rates later.  If you want a referral to ING which will net you $25 if you make a deposit of more than $250, email me at dong AT askdong.com.

• Open Mutual Fund, and start making automatic investments
• If you have credit card debt, cut up the card, and setup automatic payments in excess of what you would normally pay
• Change your student loan plan to make increased payments
• Make extra payments on the mortgage

There are many other financial actions to be taken such as opening Roth IRA account which many would argue should be a top priority. What distinguishes the actions above is that they all force your hand by automatically pulling money from your pocket or in the case of cutting up the credit cards prevent you from spending money that you might not have.  By nature I’m a procrastinator. I don’t do anything until I have to do it. So when I was daydreaming about having a plan that’s all I did - daydream. However once I actually found that I had much less money to spend in my bank account, I started thinking not only about how I could better spend my money, but what I really wanted to do with that money.  Sometimes it takes a good kick in the pants to get the financial engine started.

I got email from HSBC the other day about the “Dash Sweepstake” promotion they are running between 10/6/07 and 11/30/07. The prizes are as follows:

• One $20,000 Grand Prize
• One $10,000 1st Place Prize
• Four $5,000 2nd Place Prizes

Each customer gets an entry for each $250 increase in funds (not attributed to interest), and for each week of maintaining the balance increase. I realize it’s probably a bit foolish, but I’ve decided to maximize my chances. I had some money in another savings account (Citibank) that I had once considered transferring over to HSBC. Now, I’m going to go ahead and transfer that money in $250 increments daily until 11/30/07. There are basically 36 Business days left on which I can transfer money. The total of 9600 I transfer will give me approximately 40 additional chances to win. 1 for each transfer for 36 and 1 for each week for another 4 chances I keep my balance up.

So what are my chances? Depends on the number of customers of HSBC has. My best guess is that the company has about 500k direct customers. According to this article they had about about 350k in January of 2007.  I’m sure they’ve grown since they, so 500k I believe is a reasonable estimate. My approximate chance of winning  is .008% (40 out of 500,000) - not very good odds.  My expected value if $4.20.  For those unfamiliar with expected value, it’s basically the probability of an event multiplied by the value of the event. If there were only 1 grand prize winner, my expected value would simply .008% X 20,0000 = $1.60. However because there are other prizes, I can add up the expected value of those other outcomes which totals $2.20.  $4.20 is not all that great.

HSBC is making out running a promotion like this instead of offering higher rates if all customers behave like me (both by keeping my money in and adding to it).  The truth is I’m actually losing out in interest. At Citibank I get 5% vs 4.5% at HSBC.   I get 5% via Citibank’s Ultimate Money Market Account when I make two bill pays with the linked checking account which I regularly do.  I’ve been expecting them to lower the rate ever since the Fed lowered rates, but they haven’t.  As a result of transferring over $9000 to HSBC, I’ll be out about $3.75 in interest.  Effectively, my potential winnings pays for my lost interest.