Your 401(k): Don’t Forget About it After You’ve Been Gone

Our generation is constantly on the move- personally and professionally. We tend to leap between corporate ladders rather than scale just one. While this movement can be good for your career, you may be leaving something behind at your old job- a 401(k). Don't forget about it as you're moving on.

A 401(k), as an employer-sponsored retirement plan, is always tied to a specific company. When you leave that company you lose the ability to add to your retirement account and some companies insist that your roll your account balance out of their plan within a certain time frame.  So what do you do with your 401(k)?

Start by determining how much of your account balance actually belongs to you. There are only two ways that money gets into to a 401(k)—your contributions and the company’s contributions.  Your contributions, added through withholding (deferral) of your pay, always belong to you. The funds that your company contributes, however, may have a “vesting schedule,” which means the funds do not fully belong to you until you work at the company for a set amount of time. The most restrictive vesting schedule is either a three-year cliff, where none of the company contributions are available until you have worked there for three years, or a five-year grading schedule, where you vest 20% a year and become fully vested after five years of employment. You can find your vested balance noted on your quarterly statement. If you are debating whether to leave your job you should consider your 401(k) vesting schedule, if you are close to vesting it may be advantageous to stay for another month or two.

Once you leave your job, there are four options for your 401(k)—roll it to an IRA, roll it into a 401(k) at your new company, withdraw the funds, or leave it in the old 401(k) plan.

For most people, the best option is to roll your 401(k) into an Individual Retirement Account (IRA). Rolling your 401(k) to an IRA retains its tax-advantaged status and increases your investment options. Many IRA custodians, including Charles Schwab, Fidelity, E-Trade, and TD Ameritrade, do not change fees on your account. If you are not yet eligible for your new company’s 401(k) you can add to the IRA to prevent a break in your savings, although total contribution are limited to $5,500 a year and income limitations apply to Roth IRAs. Most importantly, an IRA drastically increases your investment options. 401(k)s are typically restricted to a short list of mutual funds, while IRAs allow you to invest in stocks, bonds, ETFs, and the entire universe of mutual funds. 

Occasionally it is more advantageous to roll your account into your new company’s 401(k). A 401(k) is protected from lawsuits and bankruptcy, while state laws vary may allow the inclusion of IRAs in those procedures. Another advantage to a 401(k) is that you can take a loan from your account. If you are in dire straits and need to use some of the funds in your account, you can access them through a loan without paying taxes or incurring a penalty. You must pay the funds back within a specified time period or upon leaving the company (voluntarily or involuntarily). If you do not pay back the funds it will count as a distribution and you will owe taxes. While 401(k) loans are tricky and should only be used under specific circumstances, it is an option available in a 401(k) that is not available with an IRA.

Some companies allow you to keep your 401(k) account in their plan even after you leave the company. This is generally not recommended unless you have a platinum 401(k) plan with low fees, access to institutional mutual funds at a lower cost, and unbiased investment advice that you can access after leaving the company. This is rare. Investigate thoroughly before choosing this option, you may be charged extra fees on your account and could no longer be eligible for the investment advice paid for by the plan.

The last option is to withdraw your funds from the plan. This is truly your LAST option! While available as a last resort, you should consult with a financial advisor before cashing in your 401(k). The entire amount will be included in your income at the end of the year (unless it is a Roth) and you will owe a 10% penalty for withdrawing prior to age 59½. Your 401(k) plan should have a plan advisor available for you to talk to who can help weigh it against your other options.

So as you ride off to the next great adventure of your career, remember to take with you the knowledge you’ve acquired, the experience you’ve gained, the connections you’ve cultivated…. and the retirement savings you’ve worked so hard to build.

2013 Financial Checklist- 10 Steps for Money Success in the New Year

Happy New Years! I only have your attention for a few minutes until those other resolutions take over, so before you start scanning posts of perfect abs in three minutes a day take some time to go through these short-n-sweet steps and prepare yourself for money success in 2013. 

1.     Take Financial Inventory

Make a list of all your assets (checking and savings accounts, 401(k)s, IRAs, property) and add them up. Now list all your liabilities (student loans, mortgages, credit card debt) and subtract them from your assets. Is the resulting number positive or negative? How has it changed since last year? Check whether you have any duplicate accounts to consolidate, and check the interest rates on your savings accounts, loans and credit cards to see if you can get a better deal elsewhere. Bankrate.com is a good tool for comparing rates. Save this list for future reference and make sure someone close to you could access it if anything happened to you.

2.    Review Your Cash Flow

Notice a difference in your first paycheck of the year? One tax cut not extended this year is the 2% payroll tax holiday, which means your paycheck just shrunk by 2%. Don't be fooled by the name "payroll tax," this increase affects the self-employed too. Revisit your budget to identify areas you can reduce by that amount and make sure you continue to allocate enough to savings while keeping your expenses to manageable levels (see The "B" Word). Start planning now for large expenses in the coming year—hey, imagine if you saved for Christmas all year long instead of waiting until the end of the year?

3.    Set Financial Goals  

What do you hope to accomplish financially in 2013? Where would you like to be in one year, and in five years? Set a few short-term, mid-term, and long-term financial goals and monitor your progress each year. Defining your goals is the first step to achieving them!

4.    Check Your Credit Report

Your credit score affects everything from the interest rate on a mortgage or loan to your ability to rent an apartment or get a job. Make sure you know where you stand by monitoring your credit reports regularly. Annualcreditreport.com allows you to check your credit report from each of the three reporting agencies annually for free. Check for suspicious activity that could signify identity fraud.  

5.    Adjust Retirement Savings

The maximum contributions for retirement savings increased for 2013, so you can now contribute up to $17,500 to a 401(k) and $5,500 to an IRA. Too high for you right now? Try increasing your current contribution by 2% of your income each year until you get to the max. The maximum income levels to contribute to an IRA have also changed. If you are eligible for a company retirement plan, you lose your ability to deduct all or some of your traditional IRA contribution if your AGI is over $95,000 for married couples or $59,000 for singles. Similarly, your eligibility for Roth IRA contributions starts phasing out at  $178,000 for joint filers and $112,000 for single filers. You may need to revise your retirement savings plan if recent raises or bonuses push you over those levels. Finally, check whether your company has changed any of your 401(k) features. Is there increased/ decreased contribution matching?  Are matches now made in company stock? Do then now offer a Roth 401(k) option? Make sure you are taking full advantage of your company plan, they should have a plan advisor available to help simplify the features and answer any questions.

6.    Automate!

Make 2013 the year of simplicity. Automate your bill paying to avoid late fees and missed payments, and make sure you keep enough in your checking account to cover them. If you are worried about your cash flow you can always set up bill pay for minimum payments and then manually pay off the rest of your bill each month. Just as important is automated savings. Request that your direct deposit be split between your savings and checking account, or set up an automated transfer between the accounts each paycheck. Putting money away for the future can be tough for us spenders, so make it as painless as possible.

7.    Review Your Investments

The US stock market, as represented by the S&P 500, was up 16% in 2012, while the international indexes were up over 17% (EAFE). This means your equity holdings likely increased and are now a bigger piece of your portfolio. Take some earnings off the table by rebalancing back to your appropriate asset allocation. When looking at performance compare all of your holdings against their best-fit benchmarks to compare apples to apples. Make sure your portfolio is properly diversified and aligned with your financial goals.

8.    Review Your Insurance

Did your homeowners and car insurance increase in 2012? Shop around to see whether your rates are still competitive. The new health care laws have caused some employers to change policies, so take time to review the terms of your health coverage. And if you have dependents you should have life and disability insurance, confirm each year that the amount is enough to satisfy your family’s needs.

9.    Review Your Beneficiaries

401(k)s, IRAs, and insurance policies are examples of accounts with beneficiary designations. These accounts pass to the named beneficiary regardless of what your will states. Make sure to review your beneficiaries often, especially if there have been any marriage, divorce, births, or deaths in your family.

10. Charitable Planning

Do you have funds budgeted for donations, but end up just giving haphazardly to whichever charities catch your eye that year? Make a plan now to determine now how you want to spend your donation dollars throughout the year. Consider giving a monthly amount to organizations important to you, it is advantageous to your cash flow and that of the organization. After allocating funds to the non-profits/ schools/ churches closest to you, earmark an amount for “emergency” giving. Similar to an emergency savings account, these funds are for requests that pop up along the way, whether a friend’s fun-run or next year’s big natural disaster. 

May 2013 find you healthy, wealthy, and wise!

photo credit: Daniel*1977 via photopin cc

This post is for informational purposes only. Like most things published on the internet it is best taken with a dose of common sense. It is not meant as tax, investment, or legal advice. Your personal situation may differ, so consult with an expert for customized financial planning.

What's Your Money Mission for 2013?

Happy 2013! A new year, a new start, and a good time to evaluate your goals and commitments for the future. I appreciate the symbolism of the end of one year and the beginning of the next that invites us to take note of our accomplishments and growth, and examine how we want to better our lives.

Financial goals remain at the top of New Year’s resolutions. Pay off debt. Save more. Spend less. Earn more. Stress less. What people really want is to feel in control of their financial situation, and a whirlwind of holiday spending can leave you with a painful money hangover come January. Some people write resolutions, others set goals. The best way to start the year, however, is by defining and examining your life mission, your reason for being and comprehensive life philosophy. And since this is a financial blog, I am going to discuss the practice of actualizing your money mission statement.

What is a Money Mission Statement?

A money mission statement is a written declaration of your values and purpose that is meant to guide you and your family through your financial decisions. Money is not an end unto itself; it is a tool that enables you to live your dreams. So what does money mean to you? Does it provide security, flexibility, access? Does it allow you to provide for your family, explore the world, or help others?

Your money mission statement is unique to you and, unlike goals, does not change. While incredibly powerful on the individual level, it is even more so when you discuss with your spouse/ partner/ kids/ parents and create a family mission statement. I recommend doing this exercise alone for your personal money mission statement, and then again with your family for your family mission statement. Many couples are comprised of opposite money personalities, which can be advantageous to you as a team but a cause of frustration, resentment, and secrecy if not addressed. Be sure to include your kids in this process as well. It is easier to say yes or no to the newest gaming system if you can discuss how that decision fits into the money mission statement that your family laid out together.

Reflection Questions

Begin defining your money mission by reflecting on what is truly important to you, and what you want to accomplish in your life. Here are a few questions to get you started:

When am I most happy?

When do we feel most connected? (For couples/families)

If money were no option, what would I do for a living and why?

How can I best contribute to the world?

Where will I be as an individual in (5, 10, 20) years?

Where will we be as a family in (5, 10, 20) years? (For couples/families)

Where will I/we be financially in (5, 10, 20) years?

What does an ideal retirement look like?

What five things do I value most in life?

How would I like to build my wealth?

How do I want to spend my money?

How do I want to invest my money?

How do I want to give my money?

Reflecting on the questions will give you a good idea of your money values. Now to put it all together as a mission statement! You can use any format that speaks to you, I really like this one:

I/ our family strives to make an impact on the world by ___________. I/ we value __________________. I/we seek to build wealth by ______________. I/we seek to spend __________________. I/we seek to give to ___________________. My/ our commitment to savings allows __________________.

My personal money mission statement:

I strive to make an impact on the world by living a financial stable life that feeds my passion for family and friends, travel, food, and music, and allows me to share my time and resources with others. I value personal relationships, unique experiences, continual learning and growth, and engagement towards social good. I seek to build wealth by creating value for my clients and enhancing their lives while also enhancing the local and global community. I seek to spend consciously on items and experiences that bring me joy and to fully appreciate them. My commitment to savings allows me the financial independence to pursue my passions.

Now the next time you have a financial decision to make, you can use your money mission statement to guide you. If it is hard for you to part with money, it should help you acknowledge when it is time to spend. If you struggle to budget, it should help clarify why you want to allocate your hard-earned funds towards certain purchases over others. Most importantly it should help you gain control over your financial life and align your finances with your values.

Here’s to a health, wealth, and wisdom in the new year! Please share your experience building a money mission statement, I’d love to hear how it works for you.

How Much Should I Have In Retirement Savings At My Age?

Fidelity, a major player among 401(k) providers, announced new age-based savings guidelines last week. These benchmark values are intended to help workers stay on track for retirement, and are welcome in a world where the majority of Americans are responsible for saving for retirement on their own, with very little guidance.

According to the Fidelity guidelines, you should have 1x your annual salary at age 35, 3x at age 45, 5x at age 55, and 8x your salary in savings at retirement in order to retire on 85% of your salary. But is that enough?

The Fidelity calculation solves for an 85% income replacement ratio, which I think is fairly accurate for most people. Remember that you won't be saving for retirement anymore, which frees up a chunk of your income. In this hypothetical simulation the worker will being contributing at age 25, work and save continuously until 67, and live to age 92. The market returns used are 5.5%, and it assumes that the employee’s income rises 1.5% over inflation every year.

However, this simulation also assumes that you will collect social security immediately upon retirement, and I wouldn't bet on that. My guess is that our generation won't be able to access social security until age 70 or 75, which is actually more in line with the program's design. The problem with delayed social security income is that your early retirement income needs are likely higher than those in later retirement because that's when you are healthy enough to travel and enjoy expensive hobbies. So let’s assume that your first 5 years of retirement are funded solely by your retirement savings. If you retire with 8x your last year’s salary in savings, and in the first year you withdraw the equivalent of 85% of your salary, your withdrawal rate is over 10% a year! That is way too high. In other words, 8x your salary at retirement is not enough. 

Think of it this way: If your ending salary is $100,000, you would be aiming for a final balance of $800,000. Out of that, you would pull $85,000 the first year. That's 10.5%! I would never let a client head into retirement with that distribution plan.  I understand that the purpose of this study is to get Americans to save more (the average Fidelity 40(k) balance is $73k), but it seems to me that their benchmarks are way too low. 

Based on my calculations, the numbers should read as follows:

Age 35- 1.25x salary

Age 45- 3.5x salary

Age 55- 7x salary

Age 67- 14x salary

At 1.5% income growth, your $62,000 salary would be $100,000 at age 67, which means you would want at least $1.4 million in savings at retirement. You can then pull out $85,000 a year and still keep the withdrawal rate to 6%. This would still be a high withdrawal rate if you were planning to only withdraw from your savings, but as I mentioned earlier I do believe that social security benefits will kick in at some later point in our generation's retirement.

While benchmarks can be helpful, there are many problems with judging whether your retirement is on track by the balance at a particular point in time. It may give you a false sense of security. Two people, one who turned 35 in 2007 and the other in 2009, would have very different ideas about their retirement readiness. Another problem is that, for most people, life refuses to be linear. You may have to cut your savings during child-raising years, upon starting a new business, or during a lay-off. Finally, remember that everyone’s situation is different. A doctor who graduates medical school at age 30 with $200,000 in student loans will have a difficult time reaching those early targets, but will be able to contribute far more in the future.

Instead of your retirement account balance, focus on your savings rate. This is the area in which you have the most control. Aim to put away a total of 15% of pay (including your employer match) toward retirement each year. If your employer matches 3% of your salary, this means that you should contribute 12%. The Fidelity study actually builds up to a 15% savings rate (including employer contribution) by age 35. I actually recommend saving a portion of those funds in a Roth IRA if you qualify, so your 15% retirement contributions may look more like 5% Roth IRA, 7% 401(k), 3% employer match. If you are self-employed, pull out 15% of each check before you can spend it (as you should be doing with the taxes you will owe at the end of the year). In order to get to the 14x salary you will have to increase your retirement contributions to 20% for the last ten years of employment, which is typical for families who are able to ramp up retirement savings once the kids are through college.

Since not everyone can afford to contribute 15% right off the bat, many workers (myself included) may not get to 1.5x salary by age 35. In this case you will need to increase your savings rate a little higher to get on track. For instance, you may pay off a credit card or student loan and redirect those funds towards retirement savings. However, I wouldn't recommend lowering your contributions below 15% (again, including what your employer puts in) even if you are on track to hit the benchmark number earlier. 

You may choose to diversify your savings into different investment vehicles such as rental properties or alternative investments. Just keep in mind that 15% of your income goes into SOME sort of savings or investment vehicle every year. If you have 1.25x your current salary at age 35 and you continue to save 15% of your income, you will be on track to retire with 85% income replacement at age 67.

It bears repeating that everyone’s financial situation is different. Sitting down one-on-one with a financial planner is the best way to determine the optimal savings solution for you.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.

Planning for the Longest Vacation of Your Life- Retirement

Trying to calculate the amount that you need for retirement—your "number”— can be overwhelming and scary, especially in your 30s. Don't be afraid, be empowered. No one knows what company pensions or social security will look like by the time we retire, but we do know one thing—we cannot depend on anyone else financing our retirement. The sooner you set goals for retirement the better you will be able to adjust as life changes, and the more prepared you will be to live out your ideal retirement.

Not everyone has the same retirement need. Let's face it, your goal is to maintain your ideal lifestyle, not just to die before you run out of money. So the first step is to define your ideal retirement lifestyle. Once you figure out how much you need, then we can determine what it takes to get you there. According to the 2012 EBRI Retirement Confidence Survey, only 35% of workers age 25-34 and 41% of workers age 35-44 report having tried to calculate how much they need to save for retirement. Why bother calculating? The study also states “workers who have done a retirement needs calculation tend to be considerably more confident about their ability to save the amount needed for retirement.”

Meet Your Inputs

Before we begin the calculations, I’d like to introduce you to the variables used in the “time value of money” calculation, and the choices you make in each category:

Present Value- How much you have today. This is all of your assets earmarked for retirement. Ignore your home, your emergency fund, your checking account, and the savings you will soon spend on the vacation/ new home/ wedding of your dreams. This is not your net worth, rather the amount you have saved strictly for retirement today.

Choices: Which retirement accounts are available to you, including 401(k)s and IRAs? How much of your current assets are truly set aside for retirement?

Future Value- How much you will have in the future. There are two future values to consider: the amount of your retirement account at retirement, and the amount you would like left over when you pass away. I know what you are thinking- why do I care if there is anything left? It is important to consider whether you would like to leave funds to your kids, your favorite charity, or another loved one.

Choices: Is it important to me to leave a legacy or inheritance? How much?

Interest- The rate at which your retirement account will grow, and the rate at which inflation will grow. No matter what your financial advisor/ family member/ favorite TV pundit leads to you believe, no one knows the future market returns and inflation numbers. We do not live in a linear world and we will go through periods of high returns (and inflation) and periods of low or negative returns. Based on historical data for capital gains and dividends, I use 8% for accumulation (prior to retirement) and 6% for distribution (in retirement). The idea is that your investments are more aggressive before you retire and more conservative in retirement. I actually believe that these are conservative estimates for those of us in our 30s as the average 20-year stock market return, including dividends, is closer to 10%. I use a 3.5% inflation rate in my calculations. I'm sure you have all heard ad naseam the financial industry's disclaimer that "past performance is no guarantee of future performance." Apply it here.

Choices: How are your retirement accounts invested? Are you willing to take more risk for a potentially higher return? Can you afford to keep your savings in cash and low-return investments?

Period- How long you have to save for retirement, and how long your payouts will have to sustain you in retirement. In order to calculate both of these numbers, you must first make a retirement date assumption. Do you want to retire at 50? 60? 70? The normal retirement age for our age cohort, according to the Social Security Bureau, is 67. If you plan to retire earlier you will have to really ramp up your savings as you have a shorter period to save and those savings will have to last you a longer time. Remember also that you are penalized for retirement account withdrawals prior to age 59.5 (with some exceptions), so you will need a plan for income and healthcare prior to that age. When considering life expectancy, assume you will live into your mid- to late- 90s. This is where I would use the phrase "prepare for the worst and hope for the best," except that it infers that the "best" case scenario is dying early!

Choices: Ideally, when would you like to retire? What is your absolute date? Do you have a plan in case you are forced into early retirement?

Payments- How much is going IN your savings while you work, and how much comes OUT in retirement. This is very important, as this is the area in which you have the most control. In fact, your savings rate is single best indicator of you reaching your retirement goals. This is also the area where your ideal lifestyle comes into play, both pre- and post- retirement.

Choices: How much are you willing to forego today to save for tomorrow? How much will you need to withdraw in retirement? Does your company offer retirement plan contributions you can count towards your savings goal?  

What's My Retirement Income?

There are two primary methods of retirement income determination—the expense method, in which you calculate your actual expenses, and the income replacement ratio method, in which you simply assume a percentage of your current income. Both pose some problems. I believe it is virtually impossible to predict your expenses 30 years out from retirement. Look at the current retirees paying for internet and cell phones—who would have thought! And the issue I have with the income replacement method at this stage in our lives is that many workers in their 30s are still building their careers and growing their income. So while I prefer the income replacement ration, you will likely need to make some adjustments.

Planners typically use 70-80% of income as the replacement ratio. I have yet to see a retiree actually reduce their standard of living upon entering retirement. Who wants a lower standard of living once you actually have time to do what you want? And most retirees still have a hefty tax bill since the majority of retirement savings is tax-deferred. I prefer to determine retirement income using total current income minus retirement savings (won’t need that anymore!) and other expenses that legitimately end, like a mortgage.

So what if your income is still growing, and you would like to have more money to spend in retirement than you do now? I’m with you. My own retirement replacement ratio is 110%. It is absolutely ok to use a higher retirement replacement income in your calculation as long as you believe you will realistically make more than that amount at some point in your career. After all, we want to make sure you have money to enjoy prior to retirement!

Crunch Those Numbers

Now that you have determined your input values, you can let the calculators do the work of figuring how much your retirement account needs to be at retirement, and how much you need to save now to make it happen.

Three free internet calculators I recommend using:

https://isc.nwservicecenter.com/iApp/isc/rpt/launchRetirementTool.action (Nationwide) I like that the output screen allows you to play around with the numbers and see how changes to the variables affect the outcome.

https://www3.troweprice.com/ric/ricweb/public/ric.do (T Rowe Price) This calculator has won numerous awards, although I wish it took into account income growth.

http://www.dollartimes.com/calculators/retirement.htm - This one shows your account growth and then withdrawals year by year.

I list three because I am not completely satisfied with any of the free calculators I’ve come across. Try using all three to see where the differences lie. If your annual savings number is out of your reach, start with what you can afford and make a commitment to increase it by 5% or 10% each year. 

The most important thing to remember is that calculating your retirement goal should be an annual habit, not a one-time project. Your life will continue to change significantly prior to retirement, and as long as you are proactive with your retirement funds they will be there when you are ready to retire, regardless of life's surprises along the way.

All posts on this blog are for informational purposes only and are not intended as recommendations as they may not fit your unique situation. Check with an advisor or financial planner for personalized advice.

When I'm 64

"Would you still need me, would you still feed me, when I'm 64?"- The Beatles

Ok, so the real title for this article is "Retirement Planning: A Five Part Series", something so boring only a personal finance nerd like me would ever even open it up. But I think it's important to first take a minute to recap WHY you need to even think about retirement planning. You are young and you are just now working your way into your dream career (or figuring out which career that even is). Why should you plan now for something so distant as retirement?

Which is why I refer back to the Beatles "When I'm 64". Paul McCartney was 24 when the Beatles recorded his satire of growing old with your love. Do you think he was anticipating that the day would ever come? Ask your parents, and they will be the first to tell you how quickly time flies (like you really want to open that can of worms). The life expectancy of a 30-year-old man is 77, and 81 for a 30-year-old woman. So chances are, you will see and pass the "normal" retirement age of 65. Will you still be working? Will it be your choice or will you be financially chained to your job? The goal of retirement planning is not to set it and count down to when you can watch re-runs of Jeopardy all day, it is to ensure you have the financial freedom to do what YOU want to do, when you are still able to do it.

I have a lot of friends who do not believe in retirement. Their attitude is, "I'll never have enough money to retire and will have to work my whole life anyway, so why save?". These people will save in their 401(k)s up to the company match, and then cash it out when they switch jobs. Or they don't plan to stop working because they enjoy it, or perhaps are business owners who reinvest every spare dollar back into their business. The problem with the "work-until-you-drop-dead" retirement plan is that your job may not be there for you anymore, or your business could fail and leave you with nothing. Harsh, I know, but the reality is that unemployed Americans over 55 have been the least likely to find another job during this recession, and the most likely to take a significant pay cut (15% versus 5% for those under 55). Many are forced into an early retirement. So even if you plan to continue to work, you may not have the option. A better strategy? Save money for retirement that you can deploy at normal retirement age, and choose to defer retirement if you are willing and able at that time.

An important reason for starting your retirement savings now (versus five years to retirement) is the power of compound interest. "Compound interest is the greatest invention of mankind" is a quote attributed to Einstein, and I have yet to meet a financial professional who disagrees. This would make negative compound interest the worst invention of mankind, but I will leave that to a future post on debt.

Compound interest is earning interest on the interest you've already accumulated. Imagine you invest $1,000 at a 6% annual rate, compounding monthly. At the end of month 1, you will have earned $5 ($1,000 x [6%/12]). At the end of the second month, you will earn another $5 from the principal, and in addition you will receive 2.5 cents of interest from the $5 of interest earned last month. Literally pennies, right? But it starts to add up. At the end of the year you will have earned $61.68 in interest as a result of the compounding, versus $60 if you only earned interest on the original investment of $1,000. The compounding continues, and at the end of 10 years you would have earned $819.40, or $219.40 more than the $600 earned from the principal alone.

Now apply the magic of compound interest to retirement savings. Let's say you actually listened to your parents/ mentor/ college finance professor and started saving $150 a month for retirement at age 22. By the normal retirement age of 65, you would have $363,377 in your retirement account (assuming a 6% return) and have only put away $77,400. Now imagine you did not actually listen to afore-mentioned advice-giver and don't start saving until age 42. You would have to put away $613.55 a month to match the $363,377 in retirement savings, a total contribution of $169,340. In other words, you save twice as much of your own money but end up with the same final amount.

Reality check- most likely you will not be able to retire with only $363k in your retirement account unless you have a government pension or a really flush trust fund. It takes a lot of money to retire. Once you make it to 65, a man has a 30% probability and a woman a 40% chance of living to 90. That is 25 years of supporting yourself on your retirement savings! Assuming the traditional retirement distribution rate of 4%, $363k provides you an income stream of $14,520 a year, which is below the poverty line for a household of two. The fact of the matter is that most of us will require at least $1,000,000 to sustain our standard of living through retirement. So start saving NOW, because the sooner you start the more you can take advantage of compound interest!

From a behavioral aspect as well, it is much easier to make a habit of saving now and then slowly increase the amount than it is to start saving a large amount all at once. Needless to say, I am not one who started saving right out of school, or even when I began working for a wealth management company that works directly with retirement savings. I was 26 before I opened a retirement savings account. I began by saving $50 each paycheck and rose it every time I got a raise or paid off some debt. Now I'm up to $375 a paycheck, which is a lot for me (a natural spender) but still not enough to get me to my goals. I understand that I will have to continue raising that amount to meet my retirement lifestyle needs.

Now that I have covered the WHY of saving for retirement, I will spend the next four posts enlightening you as to the HOW:

1. Determining Your Retirement Need
2. Company Retirement Vehicles
3. Individual Retirement Vehicles
4. Retirement Vehicles for Small Businesses and Self-Employed

Try to contain your excitement as you wait in anticipation!

Indentured Servitude (or Student Loan Debt)

Education is a good thing. I strongly believe that individuals should pursue educational opportunities at all times, and that a population of educated individuals is beneficial to society. So why am I negative on student loan debt? Haven't we already established that it is "good" debt, and an investment in your future?

The problem I have with student loan debt is that it is often entered into blindly. We are encouraged to go to college, and then often post-graduate programs, in order to increase our employment potential and obtain our dream job. If we have to take out loans in order to accomplish those goals, so be it. However, when a student takes out too much in student loan debt, he or she loses freedom and becomes bound by the obligation to pay the debt. It becomes more difficult to take time off work to travel, or visit with loved ones, or move into a career that pays a large personal dividend but a small salary.

I am not against student loans. I have a loan that I pay every month, and when I do it reminds me of the value of my well-rounded education and amazing college experience. Nor do I believe students should only take out loans for majors with "economic value." My Sociology major taught me how to research, write, and most importantly how to look at the world critically, a skill I use in business every day. I know a finance major who is now a veterinarian, an geology major now a Chief Investment Officer, and a philosophy major now a CEO. College should be about learning and exploring, and the more engaged you are in your classes the more you will get out of school.

That being said, education is expensive. And while the benefit side of the cost-benefit analysis is nebulous and not entirely monetary, there is a break-even point. One example is specialized master degree programs. I recently met a student preparing to apply to post-graduate programs in physical therapy. She expects a starting salary of approximately $70,000 a year and does not anticipate much salary growth throughout her career. She talked about the schools to which she is applying, and how the programs rank. Then she told me the cost. She would need a $250,000 student loan to attend her top school. She know it's a lot, but it is for her dream job helping people, and she would complete the program as a doctor of physical therapy. That's a worthy investment, right?

I immediately pulled out my phone and started crunching numbers (yes, I am a nerd and actually have a financial calculator on my phone). At today's rates, she would owe over $2,200 every month for 15 years! At $70,000, she would be paying more than HALF her take home salary every month in student loans, leaving her only $2,000 a month on which to live. She may love her job, but is she willing to take a vow of poverty for it?

I know many others who have found themselves in an indentured servitude situation. One earns $60,000 a year and pays $1,600 each month in student loans. Another is a lawyer with $200,000 in student loans who didn't pass the bar the first time, and took several months afterwards to find a job. Add an additional $30,000 in credit card debt to his loan.

At least those stories are people who enjoy their jobs and love their work. There are others who spend hundreds of thousands of dollars to learn that they do not want to be a lawyer, a doctor, or an investment banker.

Is paying that much for an education worth it? Sometimes it is. No one can value the worth of education and experience, but you can put a price to it. A great resource for estimating the cost of your loan is the calculator at FinAid.org. It will break down your monthly payments, and also calculate the future salary you need to earn to keep those payments to 10% of your gross income. In the physical therapist's case, it is  an annual salary of $266,305.20.

Most financial institutions will only loan you money if your debt-to-income ratio is less than 36%. Substantial student loan debt makes it difficult to qualify for a mortgage or even a car loan. And while the amounts I quoted may look like a typical mortgage amount, be forewarned that the interest rates differ significantly. Right now you can get a 15-year fixed mortgage for 3%, while a 15-year student loan will cost you more than twice that at 6.8%! I find it infuriating and unfair that student loan rates are this high at a time when interest rates are effectively zero. Another disadvantage to student loans over other loans is that student loans are extremely difficult to discharge through bankruptcy, especially within the first five years of payments. You can relieve the burden of a mortgage, medical debt, and credit card debt much easier than student loan debt. Like any other loan, make sure you are comfortable with your future payments before you enter into it, even if you lose your job or drop to a one-income family.

Now for the good news. Student loans can allow you to make a significant investment in yourself and put you on the path towards your dream career.  Your education is something that no one can ever take away from you, and learning how to think and learn is invaluable. Choose your education and its cost wisely, and no one will be able to indenture you.