Author Topic: Free Money? No thanks.  (Read 6413 times)

mh1361

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Free Money? No thanks.
« on: February 14, 2014, 09:02:28 AM »
I was talking to my friends the other day about their 401k matches at work, and they didn't really see it as very valuable. One would say that he wanted to pay off all his student loans before he contributed. When I told him he was missing out on free money, he said it's not really free since he has to "pay" to get it, and since he can't touch it until he's 60. Obviously, I wasn't going to get into how to withdraw it before that with him. Any suggestions of how to explain it? Has anyone had similar conversations with a friend or anyone else?

sheepstache

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Re: Free Money? No thanks.
« Reply #1 on: February 14, 2014, 09:17:03 AM »
Well... he's paying x% on his student loan, but if he could get a rate of interest on it greater than x then he would make money not paying it off, yes?  If he gets that, then he should understand the match is a 100% rate of interest.

Re: not accessing it until he's 60, maybe ask when he _is_ planning on saving for retirement.  It's certainly easier to do it in small amounts and when he's doubling his money rather than being on the hook for all of it as he gets older.

At least wanting to pay off debt means his heart's in the right place.

sherr

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Re: Free Money? No thanks.
« Reply #2 on: February 14, 2014, 09:27:35 AM »
Well... he's paying x% on his student loan, but if he could get a rate of interest on it greater than x then he would make money not paying it off, yes?  If he gets that, then he should understand the match is a 100% rate of interest.

^ This was exactly my first thought.

Getting the company match in your 401k is an immediate 100% interest rate, not to mention the annual interest he'll receive from there on out on both his initial investment and the company's match.

mh1361

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Re: Free Money? No thanks.
« Reply #3 on: February 14, 2014, 09:39:00 AM »
I think he would understand it from the sense of a 100% interest rate (or 50% like mine), but its the fact that he won't have access to it. I don't think he's tried understanding investing at all at this point, so it might be tough for him to wrap his head around it. He's also just paranoid when it comes to money. He won't get a credit card because his parents told him they're the devil, even though he would easily be able to pay it off in full every month, and he can just use it for what he's using his debit card for right now. And with the crazy bonus offers out there, it makes it that much more worth it.

Shor

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Re: Free Money? No thanks.
« Reply #4 on: February 14, 2014, 10:01:39 AM »
I think he would understand it from the sense of a 100% interest rate (or 50% like mine), but its the fact that he won't have access to it. I don't think he's tried understanding investing at all at this point, so it might be tough for him to wrap his head around it. He's also just paranoid when it comes to money. He won't get a credit card because his parents told him they're the devil, even though he would easily be able to pay it off in full every month, and he can just use it for what he's using his debit card for right now. And with the crazy bonus offers out there, it makes it that much more worth it.
The issue is from a lack of understanding how money works, or more specifically, how you can get money to work for you. Top it off with some misguided concepts that will take a bit of growing up and courage to overcome, Maybe bring it up again when he has his student loans paid off, and he's wondering what the heck he should do with all this "new" income.

Frankies Girl

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Re: Free Money? No thanks.
« Reply #5 on: February 14, 2014, 10:04:15 AM »
Okay, just laying it out in simple sentences as if I was speaking to a friend in the same situation:

Investing while you're young means you save more money with less effort. Waiting until you're in your 30s or 40s means much more money needs to be saved to make up for the lack of time. Starting young also means that you may not have to wait until your 60s to retire.

If someone offered to give you $50 for every $100 you put in savings, you'd take them up on that, right? So why are you letting  money that is FREE from your company slip through your fingers? Put in the minimum in your 401K, and you'll probably barely even realize it's coming out of your paycheck since it is taken out before taxes. And if you get a raise in the next year, you definitely won't realize it (a raise is a REALLY good time to get in on the 401K since you were already living without that money before - so throw that extra money into the 401K!)

You can get your money out before you're "old"  - if you want me to explain how that works, I'd be happy to, but there are plenty of ways to access it.

AND an added benefit, your saving in a 401K - a tax sheltered account - means it is reducing your taxable income and that means there's less money you owe to the IRS, even though you get to keep the money and it's working for you - that is a HUGE win/win.

I think it's really great that you want to pay off your school loans. But you're making regular payments and your interest rate is below 7% (at least I hope it is) it's not going anywhere or hurting your ability to work or live as you like. Not saving for retirement CAN hurt you if you end up in your 60s and are unable to work any more, but don't have much savings to support yourself. Even if you're throwing some extra at the school loans, that doesn't mean you can't save for the future while you're paying off the past.


skunkfunk

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Re: Free Money? No thanks.
« Reply #6 on: February 14, 2014, 11:55:48 AM »
You can get your money out before you're "old"  - if you want me to explain how that works, I'd be happy to, but there are plenty of ways to access it.

Hmm. Can you explain to me how to do that? I currently have a 25% employer match that I am maxing out. I'm concerned that I'll not be able to touch it until a decade or two after I'm retired.

TreeTired

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Re: Free Money? No thanks.
« Reply #7 on: February 14, 2014, 12:04:49 PM »
When I go to the grocery store and they have items that are "buy one, get one free"  am I really getting one free???

Quote
Can you explain to me how to do that?
There is another thread.... probably several threads where this process is described in detail.

I think I can give you the brief summary.

When you retire at age 35 you can roll your entire 401K balance into a traditional IRA.  This transaction should be tax free.


Now you are retired and your income is very low.  Depending on your income and tax bracket you may be able to convert a portion of your new traditional IRA into a Roth IRA.  If you can use $10,000 in extra income without paying additional income taxes, then you convert $10,000.   I have been able to convert $25,000 without increasing my federal tax burden (because I had deductions and credits at the time).

5 years after you convert to a Roth you can withdraw your contributions tax free, regardless of your age.   Any gains in the Roth have to stay in the account until age 59 1/2 to remain tax and penalty free.

Did I get that right?

sheepstache

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Re: Free Money? No thanks.
« Reply #8 on: February 14, 2014, 12:23:32 PM »
In addition to what Frankie's Girl is saying, two possible other tactics:

Point out to him that the 401K offers a money market account (if it does) and therefore he doesn't have to worry about its losing value.  Not the way of the mustache, but sometimes younger people are more risk averse.  I find that once I get past the hurtle of explaining to someone why a tax-advantaged account is a good idea, the hurtle of what to invest it in is equally difficult.  With cash, he wouldn't have to think about that right now.

See you can get him interested in just 10 or 25 dollars a month.  He may be psyching himself out by thinking he has to max out the matching.

In other words, lower the risk and inconvenience threshold so that he gets in the habit.  Once the practice of contributing and locking the money up is established, he may be able to think about it more rationally.

Frankies Girl

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Re: Free Money? No thanks.
« Reply #9 on: February 14, 2014, 12:58:28 PM »
When I go to the grocery store and they have items that are "buy one, get one free"  am I really getting one free???

Quote
Can you explain to me how to do that?
There is another thread.... probably several threads where this process is described in detail.

I think I can give you the brief summary.

When you retire at age 35 you can roll your entire 401K balance into a traditional IRA.  This transaction should be tax free.


Now you are retired and your income is very low.  Depending on your income and tax bracket you may be able to convert a portion of your new traditional IRA into a Roth IRA.  If you can use $10,000 in extra income without paying additional income taxes, then you convert $10,000.   I have been able to convert $25,000 without increasing my federal tax burden (because I had deductions and credits at the time).

5 years after you convert to a Roth you can withdraw your contributions tax free, regardless of your age.   Any gains in the Roth have to stay in the account until age 59 1/2 to remain tax and penalty free.

Did I get that right?

Yup, for a Roth pipeline/rollover. There's at least one other method as well - SEPP/72t  - that I know of.

Roth Pipeline is dependent on the idea that you've got enough current income either in an taxable account or in your Roth (since you can withdraw the actual contributions from a Roth any time without taxes, just not the profits) for you to be able to wait for the transferred money from the IRAs to "season" until they're available to withdraw tax/penalty free.

The 72t/SEPP short explanation:
http://www.forbes.com/sites/advisor/2012/02/13/the-72t-early-distribution-from-your-ira/

« Last Edit: February 14, 2014, 01:00:29 PM by Frankies Girl »

StarryC

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Re: Free Money? No thanks.
« Reply #10 on: February 14, 2014, 02:43:10 PM »
Not recommended, but you can always just pull it out and pay taxes and penalties on it!  This isn't a good plan, but sometimes it works to convince people to start.

If he is in the 15% tax bracket, for example.
Reduce pay check $100 to go into the account.  Additional $25ish is put in based on the pre-tax nature of 401k deposits.  Matched by $125.  Account has $250.  I'm assuming it is 100% immediately vested. 
Withdraw it.  Taxed at 25% +10% penalty= 35%.  Get out $162.50!

So, if the concern is, "someday I might need it and it's locked away until I'm 60" that's not true.  If, after vesting, he loses his job, runs out of emergency funds and pulls it out, he'll STILL have more than he put in.  Again, not recommended as an actual plan for how to get your money out for early retirement, or what you SHOULD do.  But, it might make someone scared that they are locking money away reconsider. Most people who are saving nothing don't need info on a Roth Pipeline or SEPP yet.

NinetyFour

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Re: Free Money? No thanks.
« Reply #11 on: February 14, 2014, 05:47:20 PM »
I have a friend who owns a small business.  He started offering a version of a retirement plan for his employees, in which the company would match up to some amount of what the employees put in.  He was unable to convince a single employee to do it.  They saw it as "risky" and they didn't like the idea that they would be penalized if they withdrew the $$ early.  Geez.

frugally

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Re: Free Money? No thanks.
« Reply #12 on: February 14, 2014, 09:55:42 PM »
Here's my blog post on exactly how to answer this: http://www.welcome-to-the-woods.com/8/post/2014/02/get-rich-with-employer-401k-plans.html.

Hope it helps!