Retirement Archives

How to Calculate Your Roth IRA and 401k Paychecks

Posted on April 20, 2022April 25, 2022 by Chris Butler

Last updated on April 25th, 2022 , 12:20 pm

Saving for retirement is a big deal. Every one of us needs some way to survive when we age out of the workforce and retire. Some lucky few can start successful ventures and save more money than they can ever spend, but most of us need to be a little slower and more deliberate with it.

We rely on a 401(k), an IRA, or multiple accounts to fund retirement. The trouble is, it’s pretty challenging to determine just how much you’ll have to live on when you retire. There are many moving parts and different factors to consider.

Moreover, if you search online, much of what you’ll find is about saving for retirement, not how to calculate what you’ll have as a payout when you finally retire.

How can you estimate what your retirement paychecks will be?

Let’s get started.

Age of Retirement

The average retirement age varies by location, culture, and income level. The one commonality is the age of 60. With an average life expectancy of about 78 in America today, this gives you a solid two decades to enjoy the twilight of your life. Of course, some people don’t retire until 65 or even 70.

The commonality is the age of required disbursements from investments.

Both IRAs and 401(k)s allow you to start taking payments from them when you hit a certain age.

That age, as of current laws, is 59 ½.

Why the half-year, and not just 59 or 60? Who knows!

There’s probably a reason buried in the depths of time, but if there is, it’s not easy to find.

Additionally, those accounts require you to start taking payments at age 72.

On top of that, some people qualify for early disbursements, starting at age 55. Specifically, if you leave your job once you turn 55, you may be able to take payments from that job’s 401(k) plan without penalty. Like a 401(k) you own or an IRA, other accounts do not allow this exception.

The age of retirement makes a big difference in your payment calculation. The longer you want to live off your investments, the longer those investments need to last. Ideally, you will have enough principal stashed away to live solely on interest payments, but that’s not always possible. More on that later.

The other reason age of retirement matters is market volatility. The longer you want to live on your retirement funds, the more likely you’ll have to cope with a downturn. Investment accounts take advantage of the fact that, over decades, the markets always rise. In the short term, however, volatility can affect interest rates and monetary value, and significant market volatility can have a significant impact, like a global pandemic affecting the world markets.

Additional Investments and Payments

An IRA and a 401(k) are not the only possible investments you can have for your retirement; they’re just two of the most common.

When calculating your eventual retirement paycheck, remember to consider additional income streams.

Two, in particular, are relatively common.

The first is a pension.

A 401(k) is technically a form of pension, but a “traditional” pension operates a little differently. These tend to be most common in major companies and government organizations, and they’re slowly growing less common over time.

If you have one, you will likely have a fixed payment from a company pension, though you may have the option to cash it out or roll it over to another account so the company doesn’t need to deal with it anymore.

The second is Social Security. Throughout your life and your career, you pay taxes. Some of those taxes go to the government to spend as they will, some go to state governments, etc. Some of it, however, goes towards the Social Security fund. Everyone who works in America pays into Social Security, and everyone who worked in America long enough to earn enough credits is entitled to Social Security when they retire.

Social Security payments typically begin at age 62 and are usually calculated to be roughly 40% of your income level when working. Alternatively, you can delay taking your payments until age 70 to increase the amount you get each year.

Keep these two sources of retirement income in mind. Calculating your desired total retirement income requires considering all of your income streams, not just those from your primary accounts.

401(k) vs. IRA

In the title, we mention 401(k)s and IRAs as the two investment vehicles we will calculate.

Is there any significant difference between them in retirement?

The answer is not really.

There are a lot of differences between IRAs and 401(k)s, but they’re all relevant to investing in them, not taking money from them. Once you reach retirement age, taking money from either of them – or even rolling them together – is acceptable. Either way, you have a principal invested in the markets, which earns interest based on its investment package. You take money from it as required once you retire. How much? Well, that’s the question.

Roth vs. Traditional

One concern is whether your 401(k) or IRA is a Roth account or a traditional account.

This decision has tax implications which can be relevant to calculating your paycheck in retirement.

With a traditional account, the money contributed to the account is tax-free. When you file your taxes annually, you count the money you put into your investments as a deduction, effectively reducing your overall income and allowing you to invest that money without paying taxes.

The government always gets its due. When you retire and start withdrawing money from a traditional IRA or 401(k), that money you pull is a paycheck and is taxed as income. You may have to pay income tax on that paycheck, calculated based on your income tax bracket with that new income in retirement. The amount of taxes you’ll have to pay depends on your retirement account type and varies from state to state.

Roth accounts work in the exact opposite way. With a Roth account, the money you contribute comes from your money after paying income taxes on your contributions and is not considered a deduction on your taxes when you earn that money and invest it. However, since you already paid taxes on that money, you don’t have to pay taxes on the disbursements you take when you retire.

There are ways to roll a traditional account into a Roth account, but they get into more complicated tax strategies that we’re not going to discuss today. If you have a traditional IRA or 401(k), you have to consider income taxes as an additional drain on your retirement paycheck, whereas if you have Roth accounts, you do not.

There’s one other vital factor to consider: the required minimum withdrawal from your accounts. You must take a distribution every year with a traditional retirement account once you hit age 72. With a Roth, you don’t need to take any money out of it. The only requirement is that when you die, your dependents or beneficiary of your inheritance must take the distribution.

How Payouts Work

Once you reach a certain age, you can begin taking distributions from your retirement accounts. Once you reach an even later age, you will be required to do so. As mentioned above, the earliest age you can take money out of a retirement account without penalty is 55 in specific circumstances, or 59 and a half for most people. Once you hit 72, you’ll be required to take payments.

Note: This can change. The age used to be 70 and a half, but it was changed in 2019 under the Setting Every Community Up for Retirement Enhancement (SECURE) Act. It’s possible that, if you’re not already at retirement age, that age can change by the time you reach it. All of these numbers are subject to change based on the whims of the government.

The amount you must take out of your account each year is called the RMD, or Required Minimum Distribution. You can, at any time, take more out of your accounts if you wish, though this is usually a bad idea if it’s not strictly necessary, so we’ll discuss it more in a moment.

To quote the IRS:

“The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s ‘Uniform Lifetime Table.'”

If you thought that table would be simple, here’s the IRS page for it. This page is over 38,000 words long, so settle in for some serious reading.

Luckily, you can use a simple calculator to estimate how much you will need to take out. The IRS provides one here. For example, if your retirement account has one million dollars in it when you turn 75, you must withdraw $40,650.41 from the account that year. These funds work out to be a monthly income from your account of $3,387.53, though it will be subject to whatever the income tax rate will be when you retire.

Assuming you have a flat one million in your retirement account is excellent for simple math calculations, but it’s unrealistic. To calculate how much you’ll have in your account at any given age, you will want to use a retirement calculator like this one. By filling in information about your contributions and your investment vehicles, you can estimate how much you’ll be getting paid in your retirement.

The truth is, the amount you earn in retirement will vary by too many factors to offer a simple answer.

You can also always withdraw more than the minimum to maintain a standard of living you’re comfortable with.

The Dangers of Drawing on Principal

Before we wrap up, one thing to mention is the difference between principal and interest in a retirement account.

The goal of every good retirement plan is to have enough money set aside to live entirely off the interest it provides or near enough as it makes no difference. A sufficiently large investment, placed in a series of investments with high rates of return, will earn enough money each year to cover the minimum disbursement plus any extra you want to withdraw.
If you tap into the principal of the investment, however, your overall total investment value declines.

That gives you less leeway for future payments, but it makes the amount you earn from interest even lower. If you don’t take a lower amount of distribution to compensate, you can enter a cycle of ever-decreasing funds until you, eventually, run out of money.

It’s impossible to say with certainty the threshold for this. You may notice that we’ve given very few numbers throughout this post.

That’s because everyone’s situation will be different. It will vary depending on factors like:

Your life expectancy
Where your money is invested and what the rate of return is
Market performance, which is impossible to predict, especially decades into the future
Chances to the tax and legal code that may make the situation better or worse for you
Your cost of living and how much money you will need to maintain your standard of living
Any medical conditions that will require ongoing treatment and the expenses associated with it

There are too many factors to consider. You can use calculators to estimate the minimum required distribution, but it’s an estimate. You can never know for sure until you’re actually at the moment of taking the money, at which point it’s too late to plan.

It’s always best to start investing as early as possible and invest as much as possible as soon as possible. The more you have in your investments, and the longer they have to grow, the less likely you will need to worry about it when you retire.

FAQ: How Much Cash Should Retirees Keep on Hand?

Posted on April 13, 2022April 14, 2022 by Chris Butler

Last updated on April 14th, 2022 , 11:32 am

Saving is something many of us do throughout our careers. These savings are often divided between long-term and liquid investments, the latter of which can help pay for immediate expenses.

General financial advice is to have 3-6 months’ worth of expenses tucked away in savings. The more liquid these funds are, the easier they can be withdrawn for emergencies. These funds can be used to pay for immediate needs, such as vehicles and sudden medical expenses. Alternatively, you can use these funds to cover the ongoing costs of living in the event of a loss of income, giving you leeway to find a new job.

Does this advice still hold once you reach retirement age? Probably not.

In retirement, your income drops and stabilizes; you begin to get payouts from your retirement accounts, social security, and similar sources.
More importantly, in retirement you no longer have penalties for withdrawing money from your retirement accounts beyond the loss of principal for the still-accumulating growth.

Meanwhile, other expenses can start to ramp up. Medical bills grow more common and more significant as we get older and our bodies wear.

Is having a 3–6-month emergency fund still relevant in this period of our lives? Should you have more cash on hand or less when you can pull from your retirement accounts as needed?

What Does Cash Mean?

Before we dig too deep, let’s take a moment to discuss what “in cash” means. As a retiree, you want to have money accessible when you need it.

Three forms of “cash” get tossed around interchangeably, but they have slightly different implications.

The first is actual physical cash. Most of the time, no one is advocating keeping cold, hard cash on hand. You may want some physical cash for everyday expenses, particularly if you travel to places where businesses may less commonly accept cards, but that’s pretty minimal these days. Keeping physical cash around was more of a habit for those who lived through the Great Depression, where investments bottomed out. Today, hoarding physical cash can even be risky; plenty of vendors no longer accept cash, preferring to handle everything digitally.
The second is easily accessible savings. A savings account can have money pulled from it whenever you like and is often tied to a debit card for immediate purchasing power. This definition of cash is what most often what people talk about when they mention cash; it’s liquid, not tucked away in an account which you can only access indirectly, and it’s not there to linger and earn interest.
The third is a cash reserve account. Cash reserve investments are generally tied to a currency’s value. These accounts can have interest rates ranging from near-nothing (keeping your dollar value 1:1 with the value of a dollar) or rising in times of economic hardship. Federal reserve rates have sometimes been as high as 5%, offering modest growth while the money is still reasonably accessible.

For today’s post, we’re looking primarily at #2, though #1 also qualifies. The idea is to draw a line between investments that earn interest and cash on hand. You can spend these funds immediately on anything from living expenses, medical bills, and leisure purchases.

Do You Still Need an Emergency Fund?

The point of an emergency fund is two-fold.

First, it serves as insulation against hardship. If you lose your income or have a sudden considerable expense, you need to cover it without defaulting on other payments or letting unfortunate events cascade. Losing a job can quickly shift into losing a vehicle or housing if you don’t have funds to keep paying those bills while you search for new income.
The other purpose of an emergency fund is to have money on hand that you can tap into without touching your long-term investments. Before retirement age, if you want to tap into your assets, you can take out a loan against them (and kick the financial hardship can down the road until you have to repay it), or take an early withdrawal and pay a penalty fee for doing so.

Once you reach retirement age, though, do you still need that protection? You don’t need to take a loan against your retirement accounts; you can pull money from them with no penalty. Does it not, then, serve as an emergency fund itself?

Yes. You still want to avoid pulling from your long-term investments for a straightforward reason: growth.

You know by now that the point of long-term investing is to build up as much money as possible in your portfolio so that interest can compound. The more money you have, the more interest makes that money grow. The more interest makes money grow, the more money you have. It feeds back on itself.

When you pull money from your long-term investments, you lose that compounding growth. When you’re pulling out your income in retirement, the idea is for your investment to remain stable for as long as possible; you only pull from interest, so your core investment stays the same, and thus the interest stays the same.

The trouble happens in two ways.

Firstly: tapping into the principal reduces the core amount of money that is earning interest. This reduces the amount of interest, further reducing your regular income. Tapping into your principal can start a dangerous loop, forcing you to reduce your investments until you eventually drain your account.
Secondly: what happens if an economic downturn hits, as it did in 2008, or temporarily in 2020 due to Covid? Interest rates and growth plummeted during these periods. However, you need to keep paying your bills and cost of living. If you’re relying on your investments to pay your way, you have to tap into your principal. If you keep cash around, on the other hand, you can use these funds instead and ride out the financial hardship without worrying about making your investment position worse.

How Much Cash Should You Keep On Hand?

It’s impossible to give general numbers as to how much cash you should keep on hand in retirement. It all comes down to an examination of your expenses. Someone living in a home they own in a rural area in Tennessee will have significantly different costs from someone living in the Bay Area in a rented unit.

To calculate how much cash you should keep on hand, you first need to have a solid idea of your monthly expenses. Maybe you’re spending $3,000 per month on typical living expenses. Perhaps that number is closer to $10,000 for other people. Keep in mind that this number is likely to rise over time. The cost of living keeps going up in 2022, and everything from energy to food to medical care is most likely going to grow more costly.

The second thing you need to know is what other sources of income you may have. Even though you’re retired, you may have additional income streams.

Income can come in a few forms:

If you’ve worked a career that has accrued a pension, that pension will pay out once you retire, with a fixed amount each year. Pensions are less common than they used to be, but they aren’t entirely gone quite yet.
Social Security. As a government-managed and public program, social security is a basic income for anyone of retirement age. Some people don’t qualify for social security income – exceptions include a variety of relatively narrow categories of people – but it still provides a consistent, if low, income for most retirees. There’s some doubt whether social security will still be available in a few more decades, but if you’re retiring now, you should have it.
Supplementary income. Many retirees pick up hobbies they can monetize (for example, selling handicrafts online) or pick up a part-time job to have both preoccupation and income. You should count this income as well.

Now that you know how much it costs to live and how much you’re pulling in from various non-investment sources of income, what category do you fall in?

Under-covered. This scenario is by far the most common position. Your expenses are higher than your income. These expenses are paid with disbursements from your investments.
Your income and expenses balance out, so you can leave your investments alone.
Over-covered. You make more than enough from your non-investment sources; you don’t need to worry about running out of money right away.

Generally, it would help to calculate your necessary cash on hand based on the discrepancy between income and expenses.

For example, suppose that your costs of living sum up to $7,500 per month. Your income covers a little under half of your expenses, leaving $4,000 per month to come from somewhere else, typically your investments.

Let’s say you have $2,000 per month in a pension, $1,000 per month in social security, and $500 per month in part-time income.

To calculate your emergency fund, decide how many months you want to be covered. Pre-retirement, the general recommendation is 6-12 months. In retirement, opinions differ. Some financial advisors say 12-18 months, while others say 24+ months.

Consider this: the larger your cash on hand, the more insulated you will be from economic hardship by adjusting your investments. The markets can take between 6 and 18 months (or sometimes longer) to recover from a downturn, so you want at least that much set aside to pay expenses to avoid tapping into your investments which you’d be selling for a low value.

Moreover, different investment portfolios may take more or less time to recover. An investment made of half stocks and half bonds, for example, can take up to 40 months to fully recover from a downturn.

In our example, with $4,000 per month in expenses not covered by a stable income, you would want:

Twelve months of coverage, or $48,000 in cash on hand.
Eighteen months of coverage, or $72,000 in cash on hand.
Twenty-four months of coverage, or $96,000 in cash on hand.

So, somewhere between $50,000 and $100,000 is the right number in this hypothetical scenario. Your numbers will vary quite a bit depending on your unique living situation.

Just because you retired doesn’t mean you want to cash out all of your investments. Long-term investments can continue to grow as long as you have the luxury to let them. You never know how long you’re going to live after retirement or what unexpected expenses mar arise.

You want your investments to stay as large and as stable as possible for as long as possible and only tap into them in the case of an unavoidable emergency.

Remember, as well, that you may have other sources of funds in an emergency. You may be able to leverage a home equity line of credit, the funds in a Health Savings Account, or other credit lines if you need them before tapping into your retirement accounts.

Using Your Best Judgment

No one can predict what the markets will do. Over the long run, historically, they’ve gone up. Once you hit retirement age, you can no longer rely on long-term recovery from short-term downturns. To avoid financial hardship, it would help if you found the right balance of income and savings from various sources to insulate yourself from downturns.

Everyone’s financial situation is unique. The best you can do is create a plan based on what you know and make the best judgment about your future. It may be worth talking to a financial advisor directly, considering all of the unique factors in your life.

Are you close to retiring, or have you already retired? What is your primary intention for wanting to keep cash on hand? Do you have any questions for us on maintaining your retirement funds and maintaining an emergency cushion that you can access quickly? Please share with us in the comments section, and we’ll get back to you with a thoughtful answer to point you in the right direction!

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Can You Contribute to Multiple 401(k) Accounts Simultaneously?

Posted on April 6, 2022April 13, 2022 by Chris Butler

Last updated on April 13th, 2022 , 02:30 pm

The humble 401(k) is among the most popular forms of retirement account. It is typically employer-sponsored and often includes employer matching (to a point), allowing retirement funds to ramp up faster than other investment vehicles simply due to the additional influx of cash.

“Before 1974, a few U.S. employers had been giving their staff the option of receiving cash in lieu of an employer-paid contribution to their tax-qualified retirement plan accounts. The U.S. Congress banned new plans of this type in 1974, pending further study. After that study was completed, Congress reauthorized such plans, provided they satisfied certain special requirements. Congress did this by enacting Internal Revenue Code Section 401(k) as part of the Revenue Act. This occurred on November 6, 1978.” – Wikipedia.

Though this form of retirement plan didn’t become popular until the 80s, it is now one of the most common plans available due to its benefits for employers and employees. Most companies that offer retirement benefits do so through a 401(k) plan today.

In the past, careers were stable. You could get a job and reasonably expect to work for that company for decades and possibly keep that same career to your retirement. Retirement parties were a common sight.

Today, company loyalty is at an all-time low, with many people job-hopping every 2-3 years. Companies often fail to provide avenues for advancement or raises, even to counteract the cost of living, so changing companies is often seen as the only way to progress in a career.

There are a ton of repercussions to this shift in employment culture, but one that many people overlook is the retirement plan. If you’re hired on to a company that offers a 401(k), and you work for them for three years, great! You have three years of contributions to your retirement account.

What happens if you leave the company and go to another that also offers a 401(k) plan? Chances are they’re with various brokerages or use different asset distributions. They open a new 401(k) for you, but your old one still exists.

Can you have two 401(k) plans legally? Can you contribute to both of them? Are there any salient details you should know?

Let’s dig in and find out.

Are There Legal Restrictions on Multiple 401(k)s?

First of all, there’s no legal restriction against having multiple 401(k) accounts. You can have multiple 401(k) accounts from W-2 employers, or you can have both an employer-sponsored 401(k) and an individual 401(k) as suits your needs.

It’s pretty typical for people to have more than one 401(k). There are no laws or regulations against it. If you change jobs, you can keep your old 401(k), roll it over into your new account, consolidate it, or even take a payout.

However, there is one restriction: your old 401(k) needs to have at least $5,000 in it to maintain it. If it has less than that amount of money, the employer is entitled to shuffle that money around, often rolling it into an IRA. If your old 401(k) has less than $1,000, they will cash it out and send you a check.

The other limitation is that you cannot contribute to an old 401(k) from an employer you no longer work with. You can’t tell your new employer to contribute to your old account, nor can you contribute to it; after all, your old employer has no real incentive to help you with your retirement; they’re not allowed to do anything with those funds other than continue to manage them.

How to Contribute to More Than One 401(k)

So, wait. If you can’t contribute to an old employer’s 401(k), how can you contribute to more than one 401(k)? There are two options.

The first is having an employer 401(k) and an individual 401(k).

Individual 401(k)s are only available to people who have their own companies or are self-employed. Individuals with self-employment income and people who have C corps, S corps, or LLCs and no employees can create their 401(k) plans.

The individual 401(k) is unique in that the contribution limits are higher because you can “match” your contributions as both the employee and the business owner; you can “match” your contributions. This strategy isn’t “free” money the way an actual employer match is – since you’re contributing both sides, rather than one side coming from a company – but it effectively allows you to have a much higher contribution limit than a standard 401(k).

The second option is to have more than one job.

If you work two jobs, and both of them offer 401(k) plans to their employees, you are free to have both. In some cases, this can be a good idea because it allows you to access different asset mixes and funds and accrue more employer matching above the contribution limits.

What are The 401(k) Contribution Limits?

There are two relevant 401(k) contribution limits you need to know.

The first is the individual contribution limit. This contribution limit is a limitation that applies to all 401(k)s. In 2022, that limit is $20,500.

A 50/50 split means each 401(k) would support up to $10,250 and not a penny more. So, if you have one 401(k), you can contribute up to $20,500 to it. If you have two 401(k)s, you can contribute up to $20,500 to all accounts combined.

The distribution can vary. If you want to put $20,000 in one 401(k) and $500 in the other, you can do so. It would be best if you simply made sure neither employer over-funds your accounts through automatic contributions. If you over-contribute, you may be subject to additional taxes on the excess, and you’ll be required to remove the extra contributions, paying the 10% early withdrawal penalty. In general, over-contributing is penalized and isn’t worth trying to do.

There’s a second contribution limit, though, and it’s the most exciting. It’s the employer contribution limit. This limit, as of 2022, is $61,000.

There’s one quirk, however. This limitation is calculated per employer rather than per employee.

In other words, both of your employers can potentially contribute up to $61,000 to your 401(k)s. If you work two jobs and have two employers, and all three of you max out your contributions, that’s $20,500 + $61,000 + $61,000.

Employer contributions are usually based on a percentage of the employee’s salary and contributions, carefully calculated to be as minimal as possible while still compelling to the employee. Very few companies will max out contributions for most of their employees. However, that’s a more social and political discussion than a legal one.

If you’re using an individual 401(k) as a self-employed person with a day job, you can contribute to both the employer and employee side of your individual 401(k).

Imagine a scenario such as this:

You work a W-2 job with 401(k) matching, dollar for dollar, up to your contribution limit.
You have a lucrative LLC on the side.

You have three relevant values here:

You can contribute as your LLC by up to $61,000.
Your individual contribution limit is $20,500.
Your W-2 employer will match up to $20,500.

That means you can potentially have $102,000 added to your 401(k)s throughout the year.

If your W-2 employer wanted, they could even contribute more, up to that $61,000 amount, though it’s relatively unlikely to happen.

This practice is perfectly legal; you simply need the funds to supply the account from your LLC.

Remember, too: if you’re over 49 years old, you can add “catch-up contributions” on top of your other contributions; the limits are higher for older people to better take advantage of a limited number of years of compounding interest.

Before we continue, there’s one more quirk you should be aware of: employee vesting. When you sign up for a retirement plan with an employer, they will usually have a clause about “vesting” in the employer contributions.

Vesting is partial ownership of the money the employer invests in your account. If an employer has, say, 20% per year vesting, it will take five years for you to be entitled to the total amount the employer has contributed.

This contribution limit is essentially a way for an employer to avoid paying into an employee’s account, only to have that employee leave after 1-2 years and take the money with them. While most of the time, this wouldn’t be valuable to do anyway, some specific businesses and industries have excellent retirement benefits. Thus, vesting rules prevent it. It would be beneficial to do so.

In practice, what this means is that if you leave an employer before you are fully vested in their 401(k) contributions, they can keep some percentage of the money – the percentage you weren’t invested in. This limitation can be a rude awakening if you roll over an old 401(k), only to find that some portion of the value doesn’t come with you.

What to Do with Multiple 401(k)s

Suppose you find yourself in a situation where you have more than one 401(k). What should you do? What’s the correct move financially?

The truth is, there’s no one correct answer. Your best bet is to talk to a financial advisor directly. However, we can offer some general advice and scenarios.

If you left a job with a 401(k) and you started a new career with a 401(k), you generally want to do something with the old 401(k). There are several reasons for this.

If the value is too low, under $1,000, the employer will cash out the old 401(k) in your name, and you will be subject to a penalty for early withdrawal.
If your old 401(k) value is under $5,000, the employer is not required to keep a handle on it and can force you to roll it over or otherwise claim it.
Since IRAs and 401(k)s are different accounts, they are subject to additional rules, asset mixes, and management practices. If you leave the retirement account alone, your employer will likely roll it over into an IRA for you to manage on your own. After all, the employer doesn’t want to manage your money when you no longer work for them.
If the old employer goes bankrupt or collapses, it can be challenging to track down and claim the money in the old account, especially years after the fact. Of course, you’re entitled to it, but getting ahold of it can be challenging and frustrating.

Generally, the best option is to roll over your old 401(k) into your new one, so your interest keeps compounding. There are occasionally good reasons to leave your old 401(k) in place, such as taking advantage of limited investment vehicles. Again, though, talk to a financial advisor about your specific situation.

Remember that you can’t contribute to a 401(k) managed by an employer you no longer work for. While they may be required to keep managing the money if it’s over $5,000, they are not required to allow you to pay into the account.

On the other hand, if you have two 401(k)s because you’re self-employed, you can use the contributions from the employer site to invest more than you “should” be able to invest. Careful management of employer matching with your W-2 job, plus maximizing your contributions as an LLC, can be a compelling way to save more for retirement.

Summing Up

To sum things up in brief:

Yes, you can have more than one 401(k) account.
Yes, you can contribute to more than one 401(k) account if you actively work for two employers (even if one of those employers is yourself).
Your individual contribution limit is shared across all 401(k) accounts, and you will be subject to taxes and penalties if you over-contribute.

Depending on your specific situation, there are a few potential benefits to having more than one 401(k). Still, you would do best to talk to a financial advisor directly about your particular circumstances to get the best advice.

Do you have multiple 401k accounts, or are you thinking of opening one? Are you worried about hitting contribution limits? Have you had trouble rolling over your 401ks, or are you worried you’re doing something incorrectly? Please share with us in the comments below, and we’ll do our best to point you in the right direction!

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FAQ: Can You Cash Out a Life Insurance Policy for Retirement?

Posted on March 31, 2022April 6, 2022 by Mike Martin

Last updated on April 6th, 2022 , 07:07 pm

Insurance is a fact of life in our money-driven world. Car insurance is necessary to protect your vehicle and yourself from the repercussions of a collision. Medical insurance is required to obtain reasonably-priced medical care, at least in the United States. Dental insurance, Vision insurance, Renters, or Homeowners insurance; are all crucial kinds of protection.

In general, the concept of insurance is simple. You pay a monthly premium to maintain coverage. If something happens to whatever you’re covering (your vehicle, your health, your teeth, your home), the insurance kicks in to pay for whatever damage or replacement is necessary.

What about life insurance?

The tricky part about life insurance is that it’s strangely positioned in our culture.

It’s often viewed as something you don’t need to worry about until you’re old, when it may start paying out.
It’s not legally mandated how health or car insurance coverage often is.
It’s complex enough that many people don’t want to learn about it.

Life insurance sounds simple. You pay into a policy that, when you pass away, pays out to your family. This payout can help keep them financially stable as they seek to replace your income or cover funeral and other associated expenses. Of course, all too often, people don’t think about the repercussions of their passing.

There are many potential benefits to life insurance while you’re still alive, including the potential to cash in your policy for immediate financial help. The question is, how?

What Are The Benefits of Life Insurance?

There are quite a few benefits to life insurance, both for you and your family.

1. It’s tax-free when it pays out.

First and foremost are the tax implications. Inheritance and other forms of death-based windfalls are classified as income in some form or another and are typically taxed. Life insurance policy payments are not classified as taxable income, so your family won’t have to suffer an unexpected tax burden.

2. The money isn’t restricted.

When your loved ones receive a payout upon passing, that money is treated as ordinary money. They aren’t required to use it in one specific way; instead, they can use it for anything. This includes ongoing living expenses to a child’s college education, funeral expenses, and more.

This can be an extremely beneficial windfall for many. Considering that recent estimates place 64% of the population living paycheck to paycheck, having the insulation of a payout for many unforeseen costs relating to end of life can be highly beneficial.

Consider that the general recommendation for coverage is 7-10 times your annual income. This can mean 5-10 years of living expenses covered for your family, assuming a consistent standard of living and expenses.

3. You may be able to cash out your insurance policy early.

Living expenses and medical bills can pile up as you reach retirement age or older, while income generally doesn’t. The usual goal is to accumulate enough wealth in retirement savings throughout your life to live comfortably in retirement, but that’s not always possible.

You can use some forms of life insurance policy in various ways to support you in retirement, in your later years, or with specific end-of-life bills. How? Let’s discuss it in greater detail.

What Are The Different Types of Life Insurance?

If you’re hoping to get a payout for your life insurance policy while you’re still alive, you’ll need to understand the different types of life insurance and the kind of policy you have. Some types of life insurance have payouts, while others do not.

Here’s a brief rundown.

Term Life Insurance. You buy a fixed-duration policy of anywhere from one year to 30 years annually. If you pass away during that time, your family receives a payout. If you don’t, the policy expires, and no one except the insurance company gets anything. These policies have higher payouts and lower premiums to balance this risk.
Whole Life Insurance. You buy a policy that lasts until you die, whether that be five years from now or 40. You enroll, pay an annual premium, and are covered forever. You get a guaranteed return on your investment, and the policy accrues cash value as you pay into it.
Variable Life Insurance. These are variations of life insurance tied to investment accounts – the cash value of the investment rises (or falls) according to the investment vehicle attached to the policy. However, the death payout remains static, as do the premiums.

There are other variations, but these are the main versions.

A key takeaway here is that “term life insurance” cannot be cashed out. To cash out your policy or receive money from it, it needs to have some cash value.

Term life insurance generally does not have a cash value attached, while whole life and variable insurance policies do. Term life insurance may be convertible into a permanent form of life insurance and thus enable being cashed out. Still, these policies require specific riders, usually when you’re signing up for them.

How Can You Get a Payout from Life Insurance?

Generally, there are three different ways you can get a payout from life insurance while you’re still alive. Each of these ways may have sub-options, so let’s discuss them.

1. Life Settlements

First up is the life settlement. A life settlement is selling your life insurance for a one-time payment. This payment is higher than the surrender value (which I’ll discuss later) but lower than the death benefit the policy would pay when you pass.

In other words, you’re transferring your policy from yourself to a third party, usually a company that specializes in precisely this transaction.

The purchasing party becomes responsible for the premiums on the policy and receives the payout when you pass.
You receive an immediate cash payout, tax-free, which you can use for your retirement and expenses.

The biggest downside to this option is leaving your family without those benefits when you pass. If you settle your policy and then use up all of the money on retirement living expenses, your family is left with nothing but your inheritance when you pass. Of course, if you have no living family, this is a moot point.

Unfortunately, one of the biggest reasons people cash out their policy is because the lower income they have during retirement means they can no longer afford the premiums. Other unexpected expenses can require more money on hand and the desire to sacrifice uncertain future benefits for immediate tangible benefits. Selling the policy early and taking a hit is better than not being able to pay and losing your coverage entirely.

2. Cash Value

As mentioned above, whole life insurance and several other kinds of life insurance, such as variable life insurance, have a cash value attached to them. Your premiums are higher, but part of your payments goes into an account that accrues value.

In variable, indexed, and other forms of life insurance, this may be more explicit, with the cash value riding in a market account and investing in the market through normal means, similar to retirement accounts.

There are three ways for a policyholder to access the cash value of their life insurance.

1.) Surrender is the first. This means, essentially, canceling your life insurance in exchange for a payout of the insurance’s cash value. You gain the cash value when you surrender your life insurance, minus a few minor processing fees. This money is then yours to do with as you will.

Surrender may have tax implications since it is weighed against the amount you have paid as premiums. Some policies also have repercussions and penalties if you cash out while still under a specific age limit, which varies per policy.

Of course, the biggest downside of surrender is the subsequent lack of life insurance. When you pass away, your policy is already gone, so your family does not receive a death benefit.

2.) The second option is a loan. Many policies allow you to take out a loan consisting of some of the policy’s cash value. You are encouraged to repay it as a loan, though there’s generally no set repayment schedule.

These loans accrue interest if you don’t repay them. Moreover, when you pass, the value of the loan plus its interest are deducted from the death benefit paid out by the policy. The death benefit may be reduced significantly depending on how long ago you took out the loan, how much value the loan had, and how much interest accrues.

3.) The final of the three options is withdrawal. Withdrawing is similar to a loan in that it can reduce the final death payout since the payout is generally the policy value plus the cash value. Pulling cash out earlier than expected will reduce that portion of the payout.

The cash value of a life insurance policy can also be used as “implicit income” by reducing expenses. Specifically, some policies allow you to use the cash value to pay the policy’s premiums, making them more or less self-sufficient until the cash value is gone. This process leaves you with more freedom to use the rest of your money in other ways.

3. Living Benefits

The third way to get value from your life insurance policy before passing away is using the living benefits riders on your policy (if it has them). There are three main ways these benefits can occur, but these may be riders you need to attach to your policy rather than options freely available to everyone. Be sure to talk to your insurance agent to see if you have these riders.

These riders are often called Accelerated Benefit Riders. They are usually optional and may not be available on all policies. Their payouts can range from 25% to 100% of the death benefit you would receive, either as a lump sum or as monthly payments. Typically, they increase the cost of the life insurance policy along the way.

The three riders are:

Chronic Illness. If you suffer from an ongoing chronic illness and need significant help with daily tasks and ongoing expenses, you can get a chronic illness payout from your insurance. Chronic diseases include AIDS, heart disease, diabetes, asthma, high blood pressure, and more.
Long-Term Care. LTC benefits are paid out when you require ongoing, long-term care such as assisted living or hospice care, nursing home care, or other forms of continuing care. The rider helps pay for that care as long as you need it.
Terminal/Critical Illness. Sometimes, a doctor will diagnose an illness you have and estimate that you have less than 12 months to live based on similar cases and your overall health. In these cases, you can receive a terminal illness payout to help with end-of-life care and other expenses associated with that final year of life.

In general, you have to work with a doctor and meet specific requirements to access these early payment riders. If you don’t meet the criteria, you can’t get the money and will need to resort to one of the other options.

Should You Cash Out?

Whether or not to cash out your life insurance largely depends on personal circumstances, so there’s no one correct answer.

Typically, if you no longer have dependents or a family that would benefit from a death payout, receiving money early to live your own life is better than letting that money evaporate or go to the state.

Early payments may also be beneficial to maintain the quality of life and enjoy your retirement if you otherwise don’t have the money to do so.

In the end, the choice is yours.

Now, we turn to our readers. Are you weighing the pros and cons of cashing out your life insurance policy for retirement? What is your current situation? If you have any questions for us, please share them in the comments section below! We’d love to hear from you, and we make it a point to respond to our readers.

Target-Date Funds vs S&P 500 Index Funds: Which is Better?

Posted on March 30, 2022April 19, 2022 by Mike Martin

Last updated on April 19th, 2022 , 01:38 pm

Choosing between target-date funds and index funds is a very common dilemma for retirement investors with a long-term time horizon.

➥ Target-date funds are incredibly diverse investment products that aim to grow assets for a specific time frame. These low-cost funds are actively managed and restructured to offset risk as the target retirement date approaches using the “glide path” approach.

➥ S&P 500 Index funds are generally less diverse investment vehicles that have no time frame.

Because index funds have no “targeted” date, the holdings within these funds do not adapt to investors’ risk tolerance, which generally decreases with age.

For long-term, retirement-minded investors, target-date funds appear to be the better investment strategy. Why? Target funds simplify the process of saving for retirement. Instead of choosing amongst dozens of equity and bond funds, target-date funds only require you to have one position! Within this one position are numerous assets and types of securities.

But which type of fund actually performs best?

Though nobody knows what will happen in the future, this article aims to compare the past performance of target-date funds with index funds, specifically index funds that track the S&P 500 benchmark.

TAKEAWAYS

Target-date retirement funds are designed to reduce risk as time passes and the target retirement date approaches.
S&P 500 index funds represent the largest 500 companies in the US and are not custom-tailored to investors changing risk levels.
Target-date funds contain equities of all market caps, as well as bond, international, and emerging market stocks.
American stocks tend to outperform both bonds and international stocks over time.
S&P 500 index funds can be combined with target-date funds for investors looking for more American equity exposure.
Index funds typically have marginally smaller fees than target-date funds, though these higher expense ratios are negligible.

How Do Target Date Funds Work?

Target-Date Fund Definition: A target-date fund – also known as an age-based or lifecycle fund – is a mixed allocation fund that seeks to grow assets over a specified time period for a target date.

When you’re 25, you can and should take on more risk than when you’re 55.

But how do you know what proportion of your retirement and savings should be in fixed-income (bonds) versus equities at various stages of your life? What about the large-cap to small-cap ratio? And what about money markets?

Target-date funds were designed to do this work for us. These funds rebalance as the target date approaches to change with investors risk appetites, which decrease with age.

Before the target-date fund, if an investor didn’t have a financial advisor, determining asset allocation was pretty much guesswork. And there really is no right answer – just a lot of grey.

To learn more about the various asset allocation strategies, check out our article, “What’s the Best Stock to Bond Ratio for Your Age?“

To remedy this huge problem, the target-date fund was created.

Target-Date Funds History

In 1994, Barclays teamed up with Wells Fargo to create a fund that “safely” brought investors to a future date, typically a retirement date.

The result was the first target-date retirement fund. Since that time, the below firms have offered target-date funds:

The most popular provider of these target-date funds, as reported by CNBC in 2022, is Vanguard. This article is going to focus completely on funds from Vanguard, though the target-date funds from all of the above families have similar asset allocation strategies.

Since this article is going to be comparing target-date funds with index funds, let’s explore the world of index funds before we move on

How Do Index Funds Work?

Index Fund Definition: Index funds can be either mutual funds or exchange-traded funds (ETFs). Index funds seek to track the returns of a market index.

So index funds track market indices. What type of market indices do they track? Innumerable. Let’s look at a few of the more popular ones now:

In order to invest in these indices, investors can either purchase mutual funds or ETFs. ETFs are becoming more popular investment vehicles because of their low fees and high liquidity.

This article is going to focus primarily on S&P 500 index funds, specifically those offered by Vanguard. There are two main products Vanguard has that provide cheap access to the S&P 500: Vanguard’s 500 Index Fund Admiral Shares mutual fund (VFIAX) and Vanguard’s Vanguard S&P 500 ETF (VOO).

These two products are identical in almost every way. Two exceptions lie in their structure and fees:

1.) VFIAX charges a fee of 0.04%; VOO charges a fee of 0.03%

2.) VFIAX is not exchange-traded; VOO is exchange-traded

ETFs (like VOO) are exchange-traded, meaning you can buy and sell them during market hours. Mutual funds (like VFIAX) can only be traded once a day, and you never know the fill price you are going to get when you place a buy or sell order on a mutual fund.

Advantage ETF!

For these reasons, this article will be using the VOO as its benchmark when comparing the performance of target-date funds. VOO is a top-rated S&P 500 tracker, earning 5 stars at Morningstar.

ETF vs ETN vs ETC vs ETP: Learn the difference here!

Target Date Funds vs Index Funds: Similarities

Target-date funds have a lot in common with index funds. After all, target-date funds are comprised of index funds! In theory, you should be able to mirror any target-date fund on your own with index funds.

This is a good strategy for investors with both higher and lower risk tolerances than the benchmark target-date fund. For investors wanting less risk, more bond funds, as well as money market funds, can be used in tandem with the target-date fund. For more risk-on investors, equity index funds can be used to supplement target-date funds.

All investors have different risk appetites. Investing is not a one-size-fits-all business. So why are target-date funds so popular? Because they’re easy and cheap!

Let’s next look under the hood of both target-date funds and index funds.

Target-Date Funds vs Index Funds: Comparing Fees

Investing can be a costly endeavor. Funds fees can predict the future success or failure of a fund.

Fund issuers must employ teams of fund managers and price stabilizers to make sure the funds do indeed track the underlying index.

The management fees for both Vanguard’s index funds and Vanguard’s target-date funds are both very low. However, target-date funds do have marginally higher fees.

Just about all Vanguard funds are comprised of four underlying index funds. Let’s take a look at these four fund fees individually, then take a look at the expense ratios of various target-date funds.

Index Fund Fees

Fund	Expense Ratio
Vanguard Total Stock Market Index Fund Institutional Plus Shares (VSMPX)	0.02%
Vanguard Total International Stock Index Fund Investor Shares (VGTSX)	0.17%
Vanguard Total Bond Market II Index Fund Investor Shares (VTBIX)	0.09%
Vanguard Total International Bond Index Fund Investor Shares (VTIBX)	0.13%

The above funds are what constitute the vast majority of Vanguard’s target-date funds. So what fees do the actual target-date funds charge? Let’s find out!

Target-Date Fund Fees

Fund	Expense Ratio
Vanguard Target Retirement 2030 Fund	0.08%
Vanguard Target Retirement 2040 Fund	0.08%
Vanguard Target Retirement 2050 Fund	0.08%
Vanguard Target Retirement 2060 Fund	0.08%

Given the relatively high fees for Vanguard’s “International Stock” and “International Bond” funds, the expense ratios for target-date funds are pretty much as they should be.

But what are the fees for VOO, Vanguard’s S&P 500 index-tracking ETF?

Vanguard S&P 500 ETF (VOO) Fee: 0.03%

Therefore, we can conclude that investing solely in Vanguard’s S&P 500 ETF is cheaper than investing in target-date funds.

Target Date Funds vs Index Funds: Asset Categories

S&P 500 index-tracking ETFs and mutual funds provide exposure to the 500 largest companies listed on stock exchanges in the United States. All of these companies fall under the “large cap” umbrella.

Target-date retirement funds also invest in large-caps, while adding:

Small-cap equities
Mid-cap equities
International equities
Bonds

Let’s next break down a few of these asset classes target-date funds invest in.

Target-Date Funds: Bond Exposure

We are taught from a young age that diversification is the best way to go in investing. That includes investing in both bonds AND stocks. But we are not living in our parents’ age, nor our grandparent’s age.

In 2022, interest rates are rising, but many financial professionals believe rates will never again rise to the heights of previous decades.

In fact, interest rates have been declining steadily since the Black Death of the 14th century! Many asset managers believe low-interest rates are here to stay.

So why does this matter to us? Target-date funds are quite bond heavy. Bonds are generally less attractive than stocks in low-interest-rate environments.

Over the course of a few decades, having 15% of your portfolio producing relatively poor returns may be ballast on your retirement plans.

Additionally, bonds have taken a considerable hit this year. In the first four months of 2022, Vanguard’s Total Bond Market Index Fund ETF Shares (BND) has fallen over 4%. Quite volatile indeed for a historically “safe” asset class!

Though bonds have indeed been underperforming, it is important to note that bonds provide investors a great source of retirement income.

BND 6 Month Performance

Target-Date Funds: International Exposure

➥ S&P 500 ETFs and mutual funds invest only in American companies.

➥Target-Date Funds invest in stocks from all over the world.

Let’s get right into comparing the historical performance of American stocks with international stocks:

International vs Domestic Stocks: 11 Years

Over the past 11 years, the S&P 500 (as represented by VOO in gold) has returned 314%. During this same time, international stocks have returned 22.68% (as represented by Vanguard’s Total International Stock ETF (VXUS).

Does this mean international stocks are poised for a comeback? Perhaps. But for the past 11 years, international stocks have barely kept up with inflation. For me, that’s a red flag for what’s to come.

Now that we have an idea of the different types of assets and securities that comprise target-date funds, let now compare them with S&P 500 index funds.

Vanguard's 2030 Target-Date Fund vs S&P 500

The below image shows the holdings for Vanguard’s Target Retirement 2030 Fund (VTHRX).

VTHRX Holdings

Let’s focus on that first fund, Vanguard’s Total Stock Market Index Fund (VSMPX).

All Vanguard target-date funds have this monster within them. This is where we are going to see overlap with S&P 500 index funds.

In addition to containing all S&P 500 stocks, VSMPX adds small-, mid-, and large-cap growth and value stocks.

Since this fund has a target-date only 8 years away, VTHRX (2030 target-date) is very conservative, having 35% of its holdings in bonds.

So how does this fund stack up against the S&P 500?

VTHRX vs VOO: 10 Year Total Total Return

As we can see, the S&P 500 has vastly outperformed Vanguard’s 2030 target-date retirement fund during the past 10 years.

Of course, this is to be expected given the planned retirement date for this investor is only 8 years away. As target-date retirement funds approach their specified date, the funds become more conservative and (in bullish markets) generally underperform the S&P 500.

Vanguard's 2040 Target-Date Fund vs S&P 500

Let’s skip ahead ten years and now and check out Vanguard’s Target Retirement 2040 Fund.

VFORX Holdings

As we can see, Vanguard’s 2040 fund is a little less conservative than its 2030 fund, having about 20% of its assets invested in bond funds.

Additionally, this fund has an international equity exposure of 32%, compared to the 2030s international equity exposure of 26%.

So how has this slightly more aggressive fund performed over the last ten years in relation to the S&P 500 (as represented by Vanguard’s VOO S&P 500 ETF)?

VFORX vs VOO: 10 Year Total Return

Because of this fund’s slightly higher equity exposure, it has performed slightly better than the 2030 retirement fund over the past decade. However, the fund still pales in comparison to the S&P 500.

Warning! Most financial professionals agree target-date funds are a great way for less market savvy investor's to save for retirement. The DIY yourself approach can prove to be a costly endeavor if not conducted with diligence and financial aptitude.

Vanguard's 2050 Target-Date Fund vs S&P 500

The next fund on our list is Vanguard’s Target Retirement 2050 Fund (VFIFX). Let’s see what’s under the hood!

VFIFX Holdings

Relative to Vanguard’s 2040 fund, Vanguard’s 2050 target-date fund reduces its bond exposure to 10% while increasing its international equity exposure to 36%. Additionally, its US equity exposure has increased by 6%.

So how has this more aggressive fund stacked up to the S&P 500 over the past decade?

VFIFX vs VOO: 10 Year Total Total Return

As expected, due to its more aggressive nature, VFIFX outperforms the 2030 and 2040 funds. However, when comparing VFIFX to the S&P 500, we can see it has vastly underperformed.

Vanguard's 2060 Target-Date Fund vs S&P 500

The last target-date fund we will be looking at is Vanguard’s Target Retirement 2060 Fund (VTTSX).

VTTSX Holdings

This fund currently has over 90% of its holdings in equities and less than 10% in bonds.

So how has this fund performed in relation to the S&P 500?

VTTSX vs VOO: 10 Year Total Return

The further away a target date becomes, the more Vanguard target-date funds begin to mirror one other.

Vanguard’s 2060 fund is almost an exact replica of its 2050 fund.

They both have ≈ 54% of their holdings in US stocks, ≈36% in international stocks, and ≈10% in bond funds.

The ten-year performance of the 2050 and 2060 fund is therefore almost identical.

However, when compared to the S&P 500 – again – they both underperform quite dramatically.

Target-Date Funds vs S&P 500: Which Is Right for You?

Target-date funds get a lot of things right (they produce a phenomenal diversified portfolio for individual retirement accounts) – but they get a lot of things wrong as well:

Target-date funds do not take into consideration investments held outside the fund.
Target-date funds assume all investors have the same risk tolerance.
Target-date funds do not adapt to the ever-changing financial needs of investors.
Many financial professionals believe retirement savers should have more equity exposure than target-date funds offer.

Let’s focus for a moment on the fourth item on the list.

Warren Buffet has recommended that retirement savers should have 90% of their savings in equity at all times with the remaining 10% invested in bonds.

Perhaps this approach is too aggressive, but investors do not need to choose one or the other.

A great investment portfolio strategy (particularly for traditional and Roth IRAs) is to keep a portion of your retirement savings in target-date funds while managing the remaining funds on your own. This will allow you to reach the bond/equity ratio that best suits your individual risk tolerance. This approach will also allow you to invest in more asset classes, such as real estate funds.

Additionally, having the bulk of your funds in a target-date fund will help shield you from market volatility.

Target-Date Fund vs Index Funds FAQs

Are index funds better than target-date funds?

In bull markets, index funds that track the S&P 500 tend to outperform target-date funds. However, during times of high volatility, equity index funds will generally lose more in value than target-date funds, which are more conservative.

Are target-date funds too conservative?

Many investment professionals believe that target-date funds do not provide enough equity exposure. Investors must understand their own risk tolerance before determining if target-date funds are too conservative (or too aggressive).

What is the difference between a target date fund and a index fund?

Target-date funds are very diverse products that change and grow with investors risk appetites’ (which decreases with age); index funds are static and do not adjust over time to meet investors changing needs.

Next Lesson

The Pros and Cons of a SEP-IRA for Retirement

Posted on March 23, 2022March 30, 2022 by Mike Martin

Last updated on March 30th, 2022 , 10:17 am

The best time to start saving for retirement was years ago, but the second-best time is now. If you’re seeking ways to squirrel away money for retirement, especially investment vehicles that offer significant returns over the years, you’ve probably encountered different options.

One such option is the SEP-IRA. Is a SEP-IRA a good option? Does it have any drawbacks?

Let’s discuss.

What is a SEP-IRA?

A SEP-IRA is a retirement account designed for employers and self-employed individuals. IRA stands for Individual Retirement Account, and SEP stands for Simplified Employee Pension.

In other words, it’s a retirement account aimed at individuals and small business owners as a simple vehicle for retirement that has fewer complications than a 401(k) or a traditional pension system. It’s a traditional non-ROTH IRA, which means the money you contribute is tax-deductible, and the disbursement in retirement is taxable as income.

SEP-IRA Eligibility Requirements

The SEP-IRA is not for everyone. Due to the investment rules with a SEP-IRA, they are best for small business owners with few or no employees and the self-employed.

Why? One rule. When contributing to a SEP-IRA, you must contribute an equal percentage to the accounts of your eligible employees. If you have ten employees, that can stack up quickly; conversely, if you have zero employees or work for yourself, you don’t have to worry about it.

The equal contribution rule is based on the percentage of compensation. If you pay yourself $100,000 and pay your one employee $50,000 and want to contribute 10% of your income to your SEP-IRA, that’s $10,000 to your account. The equal percentage contribution rule requires you to contribute 10% of the employee’s compensation to their account, which is $5,000. Note that this is a simplified example, but the general rule remains.

What are the eligibility requirements? To open a SEP-IRA, you must be either an individual with freelance income or a business owner with one or more employees. Note that a business owner with zero employees still counts themselves as one employee for this eligibility.

For employees, eligibility is based on income earned from the business. Eligible employees must be 21 or older and have worked for you for 3 of the last five years. Anyone meeting those requirements, and whom you have paid over $600 in a year between 2016 and 2020, or $650 from 2021 onwards, is eligible for a SEP-IRA. And by “eligible,” we mean “required”; you must open and contribute to employee SEP-IRA accounts if you have one for yourself.

Additionally, employees control their SEP-IRA accounts. You don’t get to make decisions about how they manage or use that money; you just have to contribute to it.

SEP-IRA accounts also have much higher contribution limits than traditional IRAs. A traditional or ROTH IRA typically has a contribution limit of around $6,000 (this changes from year to year; it was $5,500 in 2018 but was increased to $6,000 in 2019 and beyond).

In contrast, a SEP-IRA has a contribution limit of $61,000 in 2022, over 10x as much. However, there is a second limitation; contribution cannot exceed 25% of compensation. If you’re paying yourself $100,000, you cannot contribute more than $25,000 to your SEP-IRA account.

What Are the Benefits of a SEP-IRA?

The SEP-IRA is a powerful investment vehicle for small businesses and individuals, with many benefits. What are they?

1. Much Higher Contribution Limits

One of the most significant benefits of a SEP-IRA is the higher contribution limits. Taking 2022 as an example, you can contribute up to $6,000 to a traditional or ROTH IRA account. However, with a SEP-IRA, you can contribute over 10x as much… assuming you make enough money to do so. The 25% of compensation limit also kicks in. Anyone making less than $24,000 per year will have a lower contribution limit than a standard IRA.

Essentially, for anyone making between $24,000 and $300,000, give or take, a SEP-IRA can save much more money, much more quickly, than with another form of IRA. The increased contribution limits can be highly beneficial, particularly if you’re in your 30s or 40s and have relatively little savings in retirement funds. In a sense, it’s a way to “catch up” on investing.

2. Easy to Set Up and Manage

In most cases, setting up a SEP-IRA is as simple as filling out some information with a brokerage and letting them handle the paperwork. You can set one up manually via the IRS, as well. It’s all quick to get the account set up and running.

Additionally, managing a SEP-IRA is simple through most firms. Usually, they’ll have a selection of pre-packaged and managed investments you can buy into, shuffle funds between, and watch grow. These portfolios are balanced according to target retirement ranges or other goals and include a variety of assets, stocks, and other investments. Since it’s all managed behind the scenes by the brokerage, you don’t have to fiddle with individual purchases or watch the markets yourself.

3. Variable Contributions

Another benefit of the SEP-IRA is that you don’t have to set a contribution rate and stick to it as you do with other forms of retirement. You can contribute a maximum of 25% of your compensation one year, but if the next year is leaner, you can choose to contribute less or even nothing at all.

The requirement to contribute the same you do for your employees can make this an ethical dilemma as a business owner, but there’s no legal requirement to contribute the maximum you can.

4. Contributions Are Tax-Deductible

Like a traditional IRA, the SEP-IRA contributions are tax-deductible as a business expense. This deduction includes your contributions and the contributions you make to your employee accounts – it can amount to a reasonably significant business expense write-off in the right situations.

Of course, if you’re self-employed or have zero employees, this isn’t meaningful compared to a traditional IRA. A small business with a small handful of employees can see quite a bit of benefit from the tax implications of those deductions.

5. Non-Exclusive with Other IRAs

There are no rules against having other kinds of IRA alongside a SEP-IRA. You can still maintain and contribute to a traditional or ROTH IRA. The only potential issues are traditional IRAs’ contribution limits and their deductions, which can get a little tricky at higher income levels.

Suppose that all of this sounds good to you – great! A SEP-IRA might be an excellent choice for your investment. However, there are a few downsides to the SEP-IRA format, which you should know before diving in.

What Are the Downsides of a SEP-IRA?

Many of the drawbacks of a SEP-IRA come down to it being a traditional IRA, though a few are specific to the SEP format.

1. All-Or-Nothing Employee Inclusion

First of all, if you’re a small business with a handful of employees and set up a SEP-IRA, you must set up accounts for eligible employees.

As a reminder, any employee who meets these requirements is eligible for inclusion in the SEP-IRA:

Employees that are over the age of 21 are eligible.
Employees that have worked for you for three of the last five years are eligible.
Employees who have been paid over $600 in a year are eligible.

You cannot pick and choose to give only management, or only vested employees, access to the SEP-IRA. Your only other option is not to use a SEP-IRA at all.

2. Matched Contributions

Whatever percentage of your compensation you contribute to your SEP-IRA, you have to contribute equally to your employee’s accounts. You might be able to swing 20% of your income into contributions, but adding in 20% of each of your employees’ salaries can be more significant. While the all-or-nothing regulation doesn’t seem devastating, it becomes harsh when adding the matched contribution percentage described above.

Of course, since the contributions are tax-deductible, this isn’t as much of a burden as you might expect it to be. Generally, higher contributions are more beneficial, save for a few rare circumstances.

3. SEP-IRAs Lack Catch-Up Limits

With a standard IRA account, you have annual contribution limits of about $6,000. However, suppose you’re over the age of 50. In that case, that limit is increased to $7,000 for older people to save more for their impending retirement, to better take advantage of interest compounding in whatever short amount of time they have before retirement rolls around.

SEP-IRAs do not have this catch-up shift in contribution limits. Your limits are the same at age 21 as at age 65. With the much higher base contribution limits, this is rarely an issue; however, it’s still noteworthy for some older investors.

4. No Added Benefit for Employees

With a standard 401(k) retirement plan, one of the benefits to the employee is that they contribute from their paycheck, and their employer matches the contribution (up to a certain point, anyway). Feeding into the account from two directions gives the employee much more money to invest and build.

With a SEP-IRA, 100% of the money contributed to the account comes from the employer. The employee cannot add more funds to the account to further invest; they will have to find other forms of retirement savings to put their own money into.

Additionally, this places the burden of funding the account on the employer. You end up with many decisions to make regarding how much you contribute.

5. Early Disbursement Penalties

Investments typically come in three forms.

Accounts you can freely add or remove money from at any time.
Accounts you can withdraw money from at any time but may pay the penalty if you’re too young (under 59 ½ years old.)
Accounts you cannot remove money from unless you demonstrate financial hardship.

SEP-IRA accounts fall into the second category. There are, generally, penalties if a younger individual tries to remove money from their SEP-IRA account. However, money may still be able to be rolled over to other IRAs. Additionally, individuals may qualify for certain exemptions from the penalty, depending on various factors specified by the IRS.

Additionally, you cannot take out a loan of your SEP-IRA funds in an emergency. A penalized withdrawal is the only option.

6. Deferred Taxes

Traditional IRAs and SEP-IRAs share the same tax implications. You can deduct contributions from your taxes when you contribute but pay taxes on the money you receive as a disbursement in retirement.

Deferred taxes can be a benefit or a drawback, depending on how you expect your income to scale. The decision between a traditional and a ROTH IRA is all about timing, tax brackets, and anticipated revenue. It can be challenging to decide, considering how few of us can plan even a few years, let alone decades.

Is a SEP-IRA Worth It?

Generally, yes, a SEP-IRA is a powerful investment tool for individual freelancers and small business owners. The larger your business grows, and the more employees you have, the less valuable a SEP-IRA plan is to you. However, should you plan to remain a sole proprietor or a freelancer, a SEP-IRA can be a great way to invest a significant amount of money in a relatively short amount of time to build up compounding interest.

Additionally, many businesses can benefit significantly from the tax deduction involved in contributing to their and their employees’ SEP-IRA accounts. Talking to a financial advisor about your specific situation is ideal, but a SEP-IRA is an excellent choice in many cases.

Often, the decision will come down to choosing between a SEP-IRA and some form of 401(k). In this case, the decision is more complex; 401(k)s have higher contribution limits as well, but dual contributions have the potential to be more valuable. Again, consider speaking with a financial advisor about your specific situation to help you make an informed decision.

Are you considering a SEP-IRA for your retirement account? Do you have any employees, and how does this affect your decision? Do you have any questions for us about opening a SEP-IRA? Please share with us in the comments section below, and I’ll do my best to point you in the right direction!

What’s the Best Stock to Bond Ratio for Your Age?

Posted on July 7, 2021April 19, 2022 by Mike Martin

Last updated on April 19th, 2022 , 03:34 pm

One of the most difficult decisions investors can make in retirement planning is determining the bond/equity ratio they should have in their account and how that ratio should change as they age.

Unfortunately, there is no cut-and-dry answer to this question. In this article, projectfinace has compiled a list of 5 of the most popular asset allocation strategies in 2022 for retirement-minded investors. Although there may not be a methodology on this list that suits your particular risk profile, hopefully, we can give you some ideas and inspirations to create your own personal strategy.

Before we get started, I’d like to briefly touch upon the increasingly popular “target-date” retirement fund, offered by such companies as Fidelity and Vanguard.

TAKEAWAYS

The standard asset allocation method for years has been “100-Age”. The product tells us what percentage of retirement funds should go into stocks.
Warren Buffet recommends a “90/10” strategy, where 90% of assets are invested in stocks regardless of age.
“120-Age” is an updated version of the old “100-Age” rule. This accounts for people living longer.
A more modern idea, and perhaps the most popular, suggests investing 100% in equities until the age of 40, then gradually tapering off into fixed securities.

Target-Date Retirement Funds

Target-date retirement funds are exploding. Last year, their total assets under management surpassed one trillion dollars. The amount of inflows doesn’t appear to be slowing down. These funds have become, for many, a huge sigh of relief. Most of my friends don’t know the difference in risk between small-cap and mid-caps stocks; between emerging and international stocks. Target-date funds can be a godsend for those with little interest in a more hands-on approach to investing.

In the long run, target-date funds may very well be the best option. Fidgeting in retirement accounts is not recommended.

However, If you’re anything like myself, the idea of putting your entire IRA and 401k into a single target-date retirement fund makes you a little uncomfortable.

The “DIY” Approach

I prefer using mostly stock and bond exchange-traded funds (ETFs) in a hands-on approach. This gives me the ability to increase my retirement allocation in stocks during downturns, as well as make periodic adjustments to the various market-cap weights (mid-cap, small-cap, and large-caps) that I’m holding. If the market is constantly reaching all-time highs, I like having the option to take some profits. I rarely make a move, but I prefer being in charge of my diversification. There is also the distinct possibility I’m a control freak.

I am confident in my investment decisions and have the conviction to see them through. The one uncertainty I used to have was knowing whether or not my stock/equity to bonds ratio was what it should be. Over the years, I have read up on numerous methodologies and ultimately found the one that suited me best.

In this guide, we’re going to explore some of the more popular retirement allocation strategies. Hopefully, by the end, you’ll find a diversification class that suits your risk profile.

1) 100 Minus Age Rule

If you have any financially savvy seniors in your family, chances are you have heard the old “100 minus your age” adage before. This rule is very straightforward; simply subtract whatever your age is from 100 and voila! That is the percent of retirement funds you should have in stock. The rest go into bonds.

If you’re 30, this formula says you should have (100-30) 70% of your retirement fund in stocks. If you’re 60, you should therefore have 40% of your retirement in equities, and the remainder in bonds, money markets, and other investments deemed safer.

However, this formula no longer works. Why?

Americans Are Living Longer

In 1950, life expectancy for the average American was 68 years. In 1975, that number rose to 72. The current American can expect to roam this blue sphere for 78.7 years, 270 days, two hours, and forty minutes. Mark your calendar.

So since the old formula no longer makes sense, why do we continue to use it?

There are two reasons, neither of which are legitimate.

The formula is simple. Simple sayings have staying power. What is more simple than 100-age? It’s so easy and so obvious – how can it possibly be wrong?
There will never be a “correct” formula. The 100-age rule will never be proven incorrect because there will never be a “correct” retirement allocation rule. Why? No two investors are going to retire at the same moment, just as no two investors are going to die at the same time (pardon my morbidity).

So if this formula is broken in 2021, what works?

2) 90/10 Strategy: Warren Buffet Says...

Warren Buffet has his own allocation suggestion, which is a 90/10 ratio of equities to bonds. This stock heavy ratio does not discriminate with age but stays true from the first day of your employment to the very last.

“It is a terrible mistake for investors with long-term horizons,” the Oracle of Omaha said in 2017, “to measure investment ‘risk’ by their portfolio’s ratio of bonds to stocks.”

He went on to say that the nature of high-grade bonds actually increases portfolio risk. What he doesn’t mention, however, is peace of mind; could you sleep well on the eve of your retirement with 90% of your savings in stocks?

Probably not. But that isn’t to say you are limited to these almost polar opposite approaches to risk when investing for retirement.

3) 120 minus your age

Perhaps the most widely accepted approach to retirement asset allocation in 2021 is a revamp of the old rule “100 minus Age”.

Instead of subtracting your age from 100, this new formula suggests subtracting your age from 110 or even 120. This takes into account the longer lifespans of Americans.

If I subtract my current age of 37 from 120, that number tells me I should have 83% of my retirement assets inequities. Given how long American’s are living, most investment professionals would agree this rule better suits modernity than the antiquated 100 minus age rule.

4) 100% Stocks Until You're 40

A modern idea gaining traction suggests investing 100% of your retirement fund in stocks until you reach the age of 40. This is assuming you plan on retiring around 70, give or take a few years. Does this seem reckless? Perhaps, but the numbers show otherwise.

Over time, the stock market recovers from recessions and depressions. Take the Great Depression for example. It took the US stock market 25 years to recover and breach new highs following this period. For The Great Recession of 2007-2008, the stock market only took 4 years to recover.

What do both of these black swans have in common? Both recovery times were under 30 years, which is the time horizon most investors would until retirement when they invest all of their retirement funds into stocks before reaching 40 years of age.

Looking at the Numbers

If you’re like me, you would prefer to see the numbers rather than the narrative. Let’s next take a look at the historical performance of stocks, Treasury Bills, Treasury Bonds, and corporate bonds (rated Bbb).

The NYU Stern School of Business provided a phenomenal data table comparing the historical returns of these various categories. I went through the list and compiled my own table on the performance of these different categories, adjusted for inflation, over different time periods. Take a look below.

Inflation-Adjusted Returns

	5-Year Real Return	10-Year Real Return	30-Year Real Return
S&P 500 (includes dividends)	13.56%	12.35%	9.55%
US Treasury Bill (3-Month)	-0.88%	-1.26%	0.11%
US Treasury Bond (10- Year)	2.98%	2.80%	3.99%
Baa Corporate Bond	6.64%	5.56%	6.20%

Clearly, investing in broad-based stock indexes such as the S&P 500 has proven the better option for long-term investors. This includes all of the volatility of the past 30 years, not limited to the Early 2000s Recession, the Financial Crisis, and the pandemic.

But that said, who knows what the future has in store? History does not always repeat itself.

5) Vanguard's Target Date Allocations

We mentioned earlier in this article a great alternative to DIY investing: Target Date Funds.

Vanguard is one of the most popular companies in this arena. So what equity allocation do they choose?

From the image above, we can see that Vanguard’s “Phase 1”, which includes investors up to the age of forty, has an equity (stock) allocation of 90%. Up until that age, Vanguard appears to mirror Warren Buffet’s approach.

I bet that high stock allocation number would surprise a lot of 401k employees participating in this fund.

If we were to go off of the “100 minus age” rule, the equity allocation for an investor 40 years of age would be only 60% invested in stocks. When you’re talking dozens of years, that 30% difference could easily add up to millions of dollars.

If we look at “Phase 4” of Vanguard’s investment strategy, we see that investors aged 72-92 still have a considerable equity exposure of 30%.

Following that age, Vanguard very reasonably begins to curtail the risk.

Final Word

So which retirement asset allocation strategy is best for you? This decision would be a whole lot easier if we had a crystal ball.

I will say this – risk-averse investors rarely add into their calculations the cost of not participating in the equity market.

Remember the negative performance of Treasury Bills from the above graph? With inflation factored in, it’s very possible for investors to actually lose money on a yearly basis when they forego stocks.

The post-pandemic recovery has proven this, and should be enough motivation for stock-market-jittery investors to take on more risk.

Additional Resources

The 60/40 stock-bond weight rule needs to go on a crash diet – CNBC

The Proper Asset Allocation Of Stocks And Bonds By Age – FinancialSamurai

7 Great ETFs for Your Roth Retirement Account in 2022

Posted on May 31, 2021February 23, 2022 by Mike Martin

Last updated on February 23rd, 2022 , 09:21 am

After opening a Roth IRA account, many investors feel overwhelmed by the almost inexhaustible choices of investment options. This is in contrast to a standard company-sponsored 401k plan, where the options are often limited to one or two dozen funds.

The fewer choices you have, the less difficult your investing decisions become. The introduction of the “target-date” retirement fund in 401k plans made this process even easier, allowing investors access to complete diversification by only investing in a single fund managed for their selected year of retirement.

Though the lack of choices offered by 401k plans may be relieving at first, their limitations are surely felt over time. Company-sponsored plans are geared towards the masses, not the individual. Individual investors are like snowflakes in that everyone has different goals, ambitions, and motivations for their money. How can one align these individual preferences with so few choices?

If you’re a clean energy advocate, you have no option to invest in these companies; for an investor who believes tech is the future, there are seldom funds devoted solely to the technology industry; if you want to play it safe and invest solely in high dividend-paying ETFs, your company plan is likely to come up short.

Highlights

Roth IRA’s offer more flexibility than traditional IRAs and 401k plans.
Withdrawals from Roth IRAs are 100% tax free
Vanguard’s “VTI” ETF offers exposure to over 3,500 US companies.
Vanguard’s”VXUS” ETF offers exposure to over 7,000 international stocks.

Roth IRA

This is when the Roth IRA comes in handy. Roth IRA contributions are made with after-tax dollars but withdrawals are 100% tax-free. These retirement vehicles are perfect to supplement your 401k. With a Roth IRA, you have complete power over your money. You have choices. Many, many choices. There are over 6,000 publicly-traded companies on the New York Stock Exchange and the Nasdaq Stock Exchange alone. How do you decide what to invest in?

If you’re reading this article, you’re already ahead of the game by focusing on ETFs (exchange-traded funds). The vast majority of stockpickers underperform the market. Focusing on categories and sectors rather than individual companies has proven to be the best approach to long-term investing.

But limiting ourselves to ETFs doesn’t really solve our problem either. There are thousands of them as well!

The popularity of ETFs has been skyrocketing past mutual funds in recent years for good reason. Their fees are usually lower, they provide for better liquidity (you don’t have to wait until the market closes to buy/sell an ETF), and ETFs have no minimum investment requirements.

So let’s get right into it. Here are a few ETF reviews by projectfinance to get you started in your search.

Note! The “Expense Ratio”, represented on a percentile basis, is the total fee an investor must pay the issuer to hold an ETF. This fee is not withdrawn from an investor’s account but taken out of the ETFs net asset value (NAV).

1. Vanguard Total Stock Market ETF (VTI)

The correlation between market categories is no longer as strong as it once was. It isn’t uncommon in this new market for the Dow Jones Industrial Average to be up 3% while the Nasdaq is down 1%. In these times of diversion and volatility, the risk-on investor wants to have exposure to everything. Since it doesn’t seem volatility is going anywhere for a while, a total market ETF would work perfectly in your Roth IRA.

Vanguard’s Total Stock Market ETF (VTI) is one of the most popular ETFs out there. It has it all: a basket of 3,755 US growth and value stocks diversified across large-cap, mid-cap, and small-cap classes. For those new to investing, or those who just don’t want to spend the time deciding what to invest in, VTI is a practical and smart investment vehicle.

The best part about VTI is its fee. Its meager expense ratio of 0.03% puts traditional mutual funds to shame, who charge on average more than 1.40% in fees! Though 1.4% may not seem like much now, when your retirement savings start to get into the six and seven digits area, you will definitely feel it.

The VTI ETF, however, only has US stocks within its portfolio – what about international stocks? A well-diversified portfolio has exposure to both. Let’s take a look at VTI’s international cousin next.

Runner up for best broad market ETF: iShares Russell 3000 ETF - IWV

2. Vanguard Total International Stock ETF (VXUS)

Vanguard’s Total International Stock ETF (VXUS) is for global stocks what VTI is for US stocks. VXUS contains a basket of more than 7,000 stocks across the international spectrum, ranging from developed countries to emerging markets. Perhaps this wide diversification of companies helps to make up for VXUS’s slightly higher management fee of .08%.

This fee is still incredibly low, considering the average ETF management fee is just over 0.50%. Remembering the average mutual fund fee is 1.40%, 0.08% doesn’t sound so bad. Isn’t that easier and cheaper than purchasing the 7,000+ stocks on your own?

If you were only interested in investing in equities, you could buy VTI and VXUS and call it a day knowing you had exposure to almost every investment-worthy company in the entire world for minuscule fees.

But most investors want to diversify their asset classes to include bonds. Bonds have not been doing great recently. In light of today’s growing inflation and low-interest rates, let’s next take a look at an ETF that makes sense.

Runner up for broad market International ETF: ACWX

3. iShares TIPS Bond ETF (TIP)

Most professionals agree that all retirement accounts should have some exposure to bond funds. What percent of your retirement should be in bonds? Projectfinance dedicated an entire article to answer this question: What’s the Best Stock to Bond Ratio for Your Age?

iShares TIPS Bond ETF (TIP) is a dynamic ETF that provides an amazing hedge against inflation.

Over the past year, interest rates have been very low and bond ETFs have been losing money. The TIPS ETF, however, has been doing very well. This is because it is linked to the Consumer Price Index (CPI), thus hedging itself against these rising prices. When CPI increases, so do the coupon payments of the securities which compose TIP. This means the value of TIP and its dividends go up.

On the contrary, in times of lower prices, treasury inflation-protected securities like the TIP ETF will underperform. Therefore, this ETF must be watched closely and adjusted appropriately to changing economic conditions.

If you’re truly concerned about inflation, check out our article Inflation and the Stock Market: 5 Sectors to Consider for a few more investment ideas.

4. iShares Residential & Multisector RE ETF - REZ

The past year has been a wild ride for real estate. While commercial markets have been getting clobbered like never before, residential real estate has rarely been better. It is because of this REZ is next on our list of top seven ETF pics for your Roth IRA in 2021.

Now let’s take a look at that lofty fee of .48%. That expense ratio is 16x higher than that of VTI! So how did it make the list? Sometimes, it makes sense to pay a higher fee if the gains outweigh the expense.

The REZ ETF is appropriate for the more active investor as soaring residential real estate values may very well prove to be temporary. If you’re more “set it and forget it” minded, a more broad-based real estate ETF, such as The Real Estate Select Sector SPDR® Fund (XLRE) may be more appropriate. This ETF tracks the real estate sector of the S&P 500.

If you’d like to read up on how various real estate investment trusts (REITs) work, we have you covered there too.

5. Vanguard Small-Cap ETF - VB

Coming as a surprise for many, US small-cap (small-capitalization companies) stocks lead the post-pandemic equity recovery. This was primarily a result of extremely low Treasury yields. Generally speaking, smaller companies rely on debt more than larger companies. When debt is cheap (as it is now), the cost of their borrowing is reduced, thus their profits increase.

Assuming the Fed officials are correct in their presuming inflation will not pose a permanent threat on the markets, the future of small caps is promising.

The VB ETF offered by Vanguard is a great option for an investor looking for small-cap exposure. It is a “blend” ETF, meaning it is composed of both growth and value small-cap stocks.

VB stands out on the list of other small-cap ETFs because of its performance and a very low expense ratio of .05%.

When an investor thinks of a small-cap ETF, iShares Russell 2000 ETF IWM (IWM) often comes to mind. The expense ratio for IWM currently sits at 0.19%! That’s almost 4x higher than that of VB. Additionally, VB has historically outperformed IWM. It’s a no-brainer. VB wins here.

Runner up for small cap blended ETF: IJR

6. Vanguard Mid-Cap ETF - VO

Mid-cap (Middle Capitalization) ETFs are often a neglected component of the new DIY investor’s portfolio. Mid-cap companies are not up-and-coming, nor are they established. The market capitalization of mid-cap companies ranges between $2 and $10 billion, that sweet spot that divides them from their small and large siblings.

For an investor looking to diversify their Roth IRA, exposure to mid-caps make financial sense. In a normal performing market, the profit/loss profiles of mid-caps tend to fall right in the middle of small and large-cap companies.

Vanguard wins this category again with its Mid-Cap ETF VO because of its incredibly low expense ratio of 0.04%.

Runner up for mid-cap blended ETF: SPMD

7. ARK Genomic Revolution ETF - ARKG

Covid-19 has changed healthcare forever. Cathie Wood’s Genomic Revolution ETF Fund hopes to capitalize on these changes, as well as the future technology of medicine. To her credit, the Ark Innovation ETFs have performed superfluously well throughout the pandemic.

Lately, however, the ETFs of the Ark family have been struggling, and the Genomic Revolution ETF ARKG is no exception. It is too early to tell whether or not this is a great buying opportunity for ARKG. All we do know for certain is that change is coming in this space, and the keen eye of Cathie Wood will be there watching it all unravel very closely.

Let’s get this out of the way – the fee for ARKG is high, cash burningly high. Coming in at 0.75%, the management fees of ARKG is the highest on our list, and last for that reason. However, as with our REZ ETF pick, sometimes performance justifies the expense. There is no better case for this than ARKG. On the tail of Covid-19, ARKG has doubled the gains of its representative index.

For an investor with a long-term horizon and a strong stomach (ARKG is notoriously volatile), this ETF could potentially pay off big-time in your Roth IRA down the road.

Final Word

There are over 2 thousand ETFs in the US alone. Every single one of them is different. The only way to determine which ones are a good fit for your Roth IRA is to do the research. Find categories and sectors you believe in, then research, research, research.

There are some great free resources out there to help you, such as Morningstar. I never buy an ETF before first looking it up in Morningstar first to check its expense ratio and relative category performance.

Next Lessons

Additional Resources

Best Roth IRA Investments: You Have Options – Investopedia

Age of Retirement

Additional Investments and Payments

401(k) vs. IRA

Roth vs. Traditional

How Payouts Work

The Dangers of Drawing on Principal

What Does Cash Mean?

Do You Still Need an Emergency Fund?

How Much Cash Should You Keep On Hand?

Using Your Best Judgment

Next Lesson

FAQ: Can You Cash Out a Life Insurance Policy for Retirement?

Target-Date Funds vs S&P 500 Index Funds: Which is Better?

What’s the Best Stock to Bond Ratio for Your Age?

Are There Legal Restrictions on Multiple 401(k)s?

How to Contribute to More Than One 401(k)

What are The 401(k) Contribution Limits?

What to Do with Multiple 401(k)s

Summing Up

Next Lesson

Target-Date Funds vs S&P 500 Index Funds: Which is Better?

The Pros and Cons of a SEP-IRA for Retirement

What’s the Best Stock to Bond Ratio for Your Age?

What Are The Benefits of Life Insurance?

1. It’s tax-free when it pays out.

2. The money isn’t restricted.

3. You may be able to cash out your insurance policy early.

What Are The Different Types of Life Insurance?

How Can You Get a Payout from Life Insurance?

1. Life Settlements

2. Cash Value

3. Living Benefits

Should You Cash Out?

Next Article

What’s the Best Stock to Bond Ratio for Your Age?

The Pros and Cons of a SEP-IRA for Retirement

Target-Date Funds vs S&P 500 Index Funds: Which is Better?

How Do Target Date Funds Work?

Target-Date Funds History

How Do Index Funds Work?

Target Date Funds vs Index Funds: Similarities

Target-Date Funds vs Index Funds: Comparing Fees

Index Fund Fees

Target-Date Fund Fees

Target Date Funds vs Index Funds: Asset Categories

Target-Date Funds: Bond Exposure

BND 6 Month Performance

Target-Date Funds: International Exposure

International vs Domestic Stocks: 11 Years

Vanguard's 2030 Target-Date Fund vs S&P 500

VTHRX Holdings

VTHRX vs VOO: 10 Year Total Total Return

Vanguard's 2040 Target-Date Fund vs S&P 500

VFORX Holdings

VFORX vs VOO: 10 Year Total Return

Vanguard's 2050 Target-Date Fund vs S&P 500

VFIFX Holdings

VFIFX vs VOO: 10 Year Total Total Return

Vanguard's 2060 Target-Date Fund vs S&P 500

VTTSX Holdings

VTTSX vs VOO: 10 Year Total Return

Target-Date Funds vs S&P 500: Which Is Right for You?

Target-Date Fund vs Index Funds FAQs

Next Lesson

What’s the Best Stock to Bond Ratio for Your Age?

The Pros and Cons of a SEP-IRA for Retirement

ETF vs ETN vs ETC vs ETP: How They Differ

What is a SEP-IRA?

SEP-IRA Eligibility Requirements

What Are the Benefits of a SEP-IRA?

1. Much Higher Contribution Limits

2. Easy to Set Up and Manage

3. Variable Contributions

4. Contributions Are Tax-Deductible

5. Non-Exclusive with Other IRAs

What Are the Downsides of a SEP-IRA?

1. All-Or-Nothing Employee Inclusion

2. Matched Contributions

3. SEP-IRAs Lack Catch-Up Limits

4. No Added Benefit for Employees