[Replay] Planning for Retirement, Part II

Over the next few weeks, we’ll revisit our series on retirement planning! This week, we’ll return and discuss some retirement terms.

What are defined contribution plans? Defined contribution plans are employer-sponsored plans, where the employee contributes to their own individual account, with a possible percent match from the employer. That match may be contingent on the employee remaining at that job for a certain period of time. Examples of defined contribution plans include 401(k)s, 403(b)s, and 457(b)s.

What are defined benefit plans? Defined benefit plans are retirement plans where an employer will pay retired employees a defined amount based on a formula that often uses factors such as highest earning salaries and years of employment. Another term for defined benefit plans are pension plans.

What is portability? Portability is the ability to move funds from one employer-sponsored plan to another employer sponsored plan. Some plans can be kept with your former employer, many plans can be rolled into your new employee sponsored plan, and the majority of plans can be rolled into an IRA, which is an individual retirement contribution plan.

What are tax deferred contributions? Tax deferred contributions are not taxed until you withdraw those funds from that plan. Examples include traditional 401(k), 403(b), and IRA plans. Tax deferred is different than tax deductible – tax deductible lowers your taxable income reported to the IRS. An example of this would be charitable contributions – even if you don’t itemize, you can reduce your taxable income by up to $300 with a $300 donation to a non-profit.

What are tax exempt withdrawals? Tax exempt withdrawals are withdrawals from a retirement plan in which no taxes are due. An example of this would be a Roth 401(k), 403(b), or IRA plan. Roth retirement plans are funded by post-tax contributions, but have tax exempt withdrawals, while traditional retirement plans are funded with tax deferred contributions but have taxable withdrawals.

Next week, we’ll return and discuss the differences between 401(k)s, 403(b)s, 457(b)s and IRA plans.

[Replay] Planning for Retirement, Part I

Over the next few weeks, we’ll revisit our series on retirement planning! This week, we’ll discuss some questions and scenarios to get us thinking about saving for retirement!

Let’s start with a scenario.

Let’s say Aliyah saves $75 a month for retirement from age 18 to 28, then stops. If her retirement investments return 8%, she will have around $260,000 from just $9000 in contributions.

Now let’s say that Jason also saves $75 a month. However, he doesn’t start until age 28. He attempts to make up for this by savings all the way until age 65. Despite over $33,000 in contributions, close to four times as much as Aliyah, at 8% he will have around $200,000 in retirement savings, roughly $60,000 less than Aliyah.

This illustrates just how important saving early for retirement is in order to take advantage of cumulative growth.

Now let’s look at some data to see if people are saving for retirement early, like Aliyah in our scenario.

According to the 2016 Retirement Confidence Survey, by Employee Benefit Research Institute and Greenwald & Associates, while over 70% of employees age 35 and older are saving for retirement, only about half of employees between the ages of 25-34 have started, during the time period most beneficial for cumulative growth of retirement funds. Looking at more data from that survey, for those same employees ages 25-34 – less than 25% have at least $25,000 in savings and investments, and 60% have less than $10,000. In our earlier scenario, investing just $75 a month, and doing it for only ten years from age 18 to 28, Aliyah had over $25,000 in savings by age 35.

Part of this lack of savings may be a lack of planning. While the earlier years are so important for long-term retirement savings, the majority of young employees aren’t even thinking about it. Data from that same survey show that less than half of employees ages 44 and younger have begun figuring out how much money they’ll need to put aside to live comfortably in retirement. 

Over the next few weeks, we’ll discuss various terms, investment plans, how to calculate what you’ll need, and withdrawal strategies for retirement.

[Replay] The Five Cs of Credit, Part II

This week, we’ll conclude our revisit of our past posts on credit, credit reports, and credit scores. This week we’ll wrap up the Five Cs of Credit!

The third C is Capital. Capital is the amount a borrower is willing to put towards a potential investment. With credit, this is generally referring to a down payment. The larger the capital contribution, the less likely a borrower is to default. Many lenders, especially in the housing market, have minimum down payments for their collateralized loans, which are loans to purchase large assets like homes and cars. A larger down payment may help with your eligibility and in some cases may even qualify you for lower interest rates. There are also personal benefits to larger down payments; a larger down payment means lower future monthly payments, less interest over the life of the loan, and you’ll be less likely to go under water on your loan, meaning you owe more on the loan than the value of the asset, which is especially risky when it comes to car loans with small down payments.

The fourth C is Collateral. Collateral represent what the lender gets if the borrower defaults. This can be a number of financial assets, but very often it’s the asset your purchasing itself. If you don’t pay for car loan, the lender can repossess your car, if you don’t pay your mortgage for several months, they can start the foreclosure process. Loans with collateral are generally considered to be less risky, since the lender has a more straightforward recourse if you default. This is why you’re credit card and personal loan interest rates are likely higher than your auto loans or mortgages.

The fifth and final C is Conditions. Generally, this is referring to market conditions – the state of the economy, trends in that industry, and other external factors beyond your control. For instance, from about 2009 to 2016, interest rates were at record lows. A prospective borrower with identical creditworthiness may have dealt with interest rates multiple percentage points higher in 2007 than just five years later in 2012.

[Replay] The Five Cs of Credit, Part I

Over the next few weeks, we’ll revisit our past posts on credit, credit reports, and credit scores. This week we’ll begin our discussion on the Five Cs of Credit.

Over the next two weeks, we’ll discuss the Five Cs of Credit – what they are, how they’re applied, and why they’re important to you as the borrower

Let’s start with the what the Five Cs of Credit are. The Five Cs are five criteria that most lenders will use to measure the creditworthiness of potential borrowers. This allows lenders to get an idea of how likely a prospective borrower is to default, so they can decide what interest rate to offer, or to offer a credit or loan product at all.

Let’s start with the first C – Character. For Character, lenders are looking at your reputation and track record for repaying debts. They generally do this by looking at your credit reports and credit scores. All other factors equal, the better your credit score, and the fewer potential negative items on your credit report, the more likely you’ll be approved for a loan or credit item, and the more likely you’ll be eligible for lower interest rates. In fact, certain lenders, particularly those in the housing market, may have specific minimum credit scores needed to be eligible for their loans. We’ve talked at length about credit reports and credit scores on this site, so instead of rehashing all of those items, you can find the links to our previous posts and videos below (1, 2, 3, 4).

The next C is Capacity. Capacity measures your ability to repay a loan by looking at your income and comparing it to your installment debt. This is done chiefly by assessing your debt-to-income ratio. Your debt-to-income ratio is your total monthly debt payments divided by your gross monthly income. For instance, if you make $60,000 a year, your monthly gross income is $5000. If your car payment in $400, your personal loan payment is $300 and your mortgage payment is $1300, your total monthly debt payment would be $2000. Your debt-to-income ratio would therefore be $2000/$5000, or 40%. Generally speaking, the lower your debt-to-income ratio, the better your chances for qualifying for a loan, and certain lenders, especially in the housing market, have maximum debt-to-income ratios for a potential borrower to be eligible.

Next week we’ll return with the other three Cs of Credit!