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Ugh! UTMAs and UGMAs

I’m not sure why anyone has these accounts anymore, but they do. I mostly see them during divorces, where one spouse has tried to transfer money to the kids in

Don’t make this mistake with your 401K

It’s no secret that I love Roth IRAs. Don’t tune out because you think you make too much money to have one! Let me count the ways they’re great: No

How to screw up your 401K

I’ve recently been listening to the audiobook Nudge, by Nobel Prize winner Richard Thaler and Cass Sunstein. I had to double check the copyright date on it (2008) because their

Financial planning, James Comey, and the least bad alternative

Not to decide is to decide -Harvey Cox I’ve been fascinated to listen to James Comey describe his decision process on the interviews with George Stephanopoulos and Stephen Colbert. When

Business travel expenses: A black hole for your budget?

For a year or two after I graduated from grad school, business travel seemed very glamorous. That was until I realized you actually had to work at those cool destinations,

Ugh! UTMAs and UGMAs

I’m not sure why anyone has these accounts anymore, but they do. I mostly see them during divorces, where one spouse has tried to transfer money to the kids in hopes of keeping it out of the divorce joint property. Technically, these accounts are considered property of the children (not marital), but as with so many other financial issues, it’s largely up to what the attorneys are able to negotiate.

Funding these accounts is a pretty poor idea in most cases, however. What you’re doing is putting all the money in the kid’s name: they’re entitled to it at 18 to do whatever they want with it, and all the earnings are taxed at the parents’ rate. It used to be that as long as earnings stayed below a certain amount, the earnings were taxed at the kid’s rate so it was once a decent strategy to avoid some tax, as long as you could trust your kid not to burn through it by the time they were 18 and two months.

That tax dodge evaporated years ago, but somehow these accounts are still hanging around. Unless you’re trying to shaft your spouse, or have a child actor who’s earned the money themselves but needs some supervision, I don’t think there are many good reasons to have such an account.  They’re considered 100% the property of the child for college financial aid determinations, also.

How can you get the money out of it? The account has to be used for the benefit of the child (once funded, it’s their money), but as long as you can prove that’s how you used it, you’re fine. You’ll have to pay taxes on any gains from the sale of investments, but it’s unlikely the IRS will check up on how the money itself was spent—it’s your kid that could sue you, and hopefully that won’t be a factor.

Once upon a time I had such an account for my daughter, when the taxation was still favorable. I liked it way back then because there was no obligation to spend it on college, and I was certain my brilliant kid would get a full ride scholarship. Ha-ha. Obviously that was before I was a financial planner. We never did accumulate much in college savings in the account, being dunderheads at the time, and I eventually cashed it in to purchase her harp. She hasn’t sued me yet.

Probably the easiest way to clean out the account, besides covering tuition, music lessons, instruments, sports equipment, computers…is to move the money into a 529 plan. If you have significant gains, you’ll have to pay taxes (now playing world’s smallest violin) because 529 deposits have to be in cash. At least the (new) investment will be growing tax free.

If your child has actual earned income, you can also deposit some of the funds into a Roth IRA (up to $5,500/year depending on their earned income). They can withdraw money for college with no early withdrawal penalty, but they will need to pay taxes on any earnings withdrawn. Although they own the account once they’re adults, the tax and withdrawal penalties may slow them up a little. Also, $10,000 can be used as a down payment on a first time home purchase.

For some odd reason, most of these lingering UTMAs are also invested in savings accounts, where they’re earning practically zero for years now. I think they’re just places where people thought they were going to park some cash for college, then mostly forgot about them.  So, if you still have these accounts, resurrect them and put them to work for your kids. College is going to take whatever you can scrape together.

In case you’re wondering what these letters stand for, UTMA is Uniform Transfer to Minors Act and UGMA is Uniform Gift.

Don’t make this mistake with your 401K

It’s no secret that I love Roth IRAs. Don’t tune out because you think you make too much money to have one!

Let me count the ways they’re great:

  • No required minimum distribution at 70 ½, so you can leave the money to grow into old age if you wish.
  • Grows tax free and you pay no taxes on any of it when you withdraw after 59 ½.
  • Can always withdraw your contribution tax free.
  • Can be used for medical emergencies and a $10,000 down payment on a first house (but don’t—leave it alone for retirement!)
  • Your heirs will pay no taxes on withdrawal if any is left
  • And the biggest benefit in my opinion—if you need a lump sum in retirement (dental implant, hearing aid, relocation expenses, buying into a continuous care community), you can withdraw it tax free. If you have to withdraw from a traditional IRA or 401K, you’re going to need to withdraw what you need + taxes on the withdrawal, so much less of your money is preserved going forward.

But, you make too much money, you say? Have you checked whether your 401K at work offers a Roth 401K option? Several clients in the past month have told me they don’t have a Roth 401K because they “make too much money”. It’s true that individual Roth IRAs have an income limit of $189,000 joint and $120,000 single, but the limit DOES NOT APPLY to workplace Roth 401ks. These Roth 401ks have exactly the same limits as your current plain vanilla 401k.

One of the biggest drawbacks of an individual Roth IRA is that you have a limited amount you can contribute each year: $5,500 with $1,000 additional after 50. But this is a relatively small amount, so many Roths never get large enough to fund a retirement. NOT SO with Roth 401ks, where you can deposit $18,500, with $6,000 extra after 50. Note: your employer’s match contribution will still go into the regular 401k.

Roth 401ks were relatively uncommon just a few years ago, but now many employers are offering the choice. It’s much underutilized. Sure, you lose the current tax deduction, but in the future, you should save far more in taxes on the appreciated amount. Check out this chart to see if you’d be better off with a Roth or traditional. In almost every instance, a Roth does better. Special alert to new grads: choose the Roth! Then you’ll never get used to the tax deduction.

If you don’t know if your employer offers it, ask. And agitate for the option if you need to. It shouldn’t cost the employer much extra, if anything. And it will really pay off for you.

 

How to screw up your 401K

I’ve recently been listening to the audiobook Nudge, by Nobel Prize winner Richard Thaler and Cass Sunstein. I had to double check the copyright date on it (2008) because their advice on 401ks has definitely not gotten through to many of us. They give a lot of advice on how you should go about investing in your 401k but since it seems that, ten years later, it’s still ignored, I’m going the other way and telling you how to really screw it up. It’s my theory that there will then be a better chance of doing it right.

Don’t worry about where your investment advice is coming from. Especially don’t find out whether the “advisor” has any qualifications. Who cares how he or she is getting paid?—you’ll still get unbiased advice even if they work for a specific company and just happen to get a bonus for that company’s products. A broker is every bit as good as a CFP, right, and who knows the difference anyway?

A robo-advisor is perfectly acceptable. Filling out a questionnaire sure beats talking to someone about your personal situation. Cheaper and easier, too. And a computer program will definitely have your best interests at heart.

Content yourself with whatever default selection the company puts you in. So what if that’s a money-market fund and you make .03% for the next 20 years—you’re invested, right?

Better yet, choose your own. Want some fun? Choose two or three target retirement funds, with different years. Who knows when you’ll retire? Sure it’s the same investments, but with different proportions, so that’s diversification, no?

Let’s be fancy. Maybe a target date fund seems a little boring, so let’s mix it up with a stable value fund and an S&P 500 fund. Now we really have no idea what the risk factor is for the overall portfolio, but, well, diversification is good, right? Even better if you see the words growth, high income, or special situation in the name of the fund, that’s the one for you, because everybody wants those qualities.

Buy a lot of your company’s stock. Maybe you can even get it at a discount. Management will surely smile on this. And if the company takes a big downturn, not only can you get laid off, but at the same time you can lose all your retirement. But that’s not going to happen because you can be sure the company will be sold and you’ll get rich off the buyout. Just ask the former employees of Enron and Worldcom.

Never contribute more than the company will match. Because who wants tax savings? Who wants investments to grow tax free? And besides, you’re saving 3% so that ought to be enough for retirement, right?

Never increase your savings rate. Even if you get a raise, why should you waste it on savings?

Start as late as possible to contribute. Your fifties seem about right. You’ll have plenty of time to enjoy life down to the last penny now, and can worry about retirement later. And later.  And later.

Never offer any input on the plan when you have the opportunity.  We can all trust our employers to be much more concerned with retirement than we are. They’ll worry about keeping fees low for employees (not how much the plan costs the employer) and will make sure you have plenty of low cost index funds to choose from. They know best.

When you change jobs, either cash out the account or forget about it. Cashing it out is the most fun, until tax time rolls around. But the easier way is just to forget about it, and not bother with whatever it’s invested in. That way you’ll never know how much you have, be bothered worrying about the return, and it might just go to the state as an abandoned account.

Okay, folks, because this is the internet, I want to be perfectly clear that this is satire, not advice. No one should act on investment advice without consulting an advisor (or doing sufficient research) to reach decisions based on your personal situation.  But I think Thaler and Sunstein might agree that doing the opposite of what’s in this post might be the better course.