You may be able to take a 401k loan, where you can borrow against the money you’ve accumulated in your retirement account.  If you find yourself in a tough situation where you need money quickly a 401k loan might be tempting but be aware there are some potential risks.  Today we’ll look at the pros and cons of a 401k loan and some frequently asked questions.

401k Loan Rules

How does a 401k loan work? Your best resource is your plan sponsor. Each employer-sponsored plan can be different, and your plan is not required to allow you to take a loan.

If your plan does allow you to borrow from your 401k plan, these rules apply:

• you may only borrow a maximum of 50% of your vested account balance, with a cap of $50,000
• unless you are buying a home, you must repay the loan within 5 years of borrowing the funds
• you must make consistent payments (at minimum, one per quarter) until the debt is repaid

Upside to borrowing From Your 401k

It seems like a pretty good deal. You can borrow from yourself, and the interest you pay back on the loan goes back into your retirement pocket. You don’t end up losing money by paying interest to a bank or credit card. The interest you pay goes from your checking account to your retirement account. It stays under your control. That is a major benefit of borrowing from your 401k plan.

A second benefit is no credit check is required. There are no qualifications set in place. You don’t have to have a certain credit score: the money is yours to borrow as needed.

Risks of Taking a 401k Loan

As nice as paying yourself interest sounds, there are some significant risks to consider with this type of borrowing. The first major concern is that any change in your job status normally means you must repay the loan within 60 days. That means if you lose your job or willingly leave the company, you must have funds available to repay the loan almost immediately. If you’ve just lost your job it might be difficult to repay the loan that fast.

If you can’t repay the loan, whether through job loss or not, your initial withdrawal of the funds will be treated as a taxable distribution. You will then owe income tax on the funds you borrowed plus a 10% fee to the IRS assuming you are under age 59 and a half. Even if you can eventually repay the loan, you will pay an origination fee and potentially a maintenance fee tacked on top of it. Your “free loan” to yourself probably won’t be exactly free.

Another risk is the potential loss of investment gain from removing funds from your portfolio. It would be great to avoid a market crash if you could time the market (something that is impossible to really do), but what if your portfolio grows 50% over that maximum 5 year loan period? The investment gains you leave behind can make other forms of borrowing look inexpensive in comparison.

An additional consideration is borrowing when times get tough sets up a bad habit of borrowing. When your expenses go up, your income goes down, or both, the last resort is to borrow money. A better course of action is to cut back on your expenses or find a way to increase your income again. Borrowing from your 401k is a risky, but easy “out” in this situation.

Alternatives to Borrowing From Your Retirement Plan

As mentioned above the best alternative to borrowing from your financial future is to cut back, sell items you own, or grow your income. Borrowing shouldn’t be your first option.

You could consider taking a home equity loan or utilizing a home equity line of credit, but in doing so you will be paying interest to the lender rather than to yourself. The upside to a HELOC over a 401k loan is the loan does not instantly become due if you change or lose your job.

In recent years a new credit market has emerged that offers person-to-person loans.  There are a few P2P lending companies like Lending Club and Prosper that let you apply for loans that are funded by a group of other people.  You still have to go through a loan application process and they evaluate your credit but the fees and rates can be less than going through a bank.

If you need money for a short period of time and don’t mind increasing your risk, you may be able to swing a 0% financing deal with a new credit card. Of course the credit card company is willing to take this risk on the assumption that you will slip up at some point in the future, and owe them a lot in fees and interest charges.

401k Loan Frequently Asked Questions

Q: How much can I borrow from my 401k?

A: Up to 50% of your total vested account balance to a maximum of $50,000. You could borrow $50,000 only if your account had at least $100,000 in it.

Q: Is borrowing from my 401k tax deductible?

A: No.

Q: How quickly do I have to repay the loan?

A: Within 5 years of borrowing unless you leave the company or lose your job. Your 401k loan cannot be rolled over to a new plan, and your loan may be due within 60 days of a job status change. (If you borrow to finance a home purchase, your terms can be longer — up to 15 years.)

Q: What fees will I incur with a 401k loan?

A: You will owe yourself interest, and pay an origination fee to the plan sponsor. You may also pay a maintenance fee. If you cannot repay the loan it will be treated as a non-qualified distribution and you will owe the IRS a 10% fee plus income tax on the amount borrowed.

One of the most popular types of investment accounts to use for retirement is an employer-sponsored 401k plan. Using a 401k for retirement is usually an simple option. You fill out a form at work and the money comes out of your paycheck every time you get paid. You don’t have to actively think about investing, and some employers automatically enroll employees to invest 3% of their pay.

But what if you are not a fan of your 401k? What if your employer doesn’t offer a match, or your investment options are poor? Here are a few alternatives to investing in a 401k.  (If you are self employed you have other options that aren’t included here but will be covered in a future post).

Tax-Deferred: Traditional IRA
A traditional IRA is a tax-deferred individual retirement account. These accounts fall under IRS rules for IRAs, meaning you can contribute up to $5,000 per year (or $6,000 if you are over age 50) toward your retirement. You get a tax deduction today, and pay income tax when you hit retirement and start pulling funds out. Your ability to contribute is determined by whether or not your income goes over specific IRS benchmarks. You won’t be able to set aside as much money for retirement as you would in a 401k, but you gain the freedom of being able to choose exactly what investments you want to use.

• Upside: tax-deferred like a 401k, ability to choose investments
• Downside: can’t contribute as much as 401k, may be limited if your income is very high

Tax-Free at Retirement: Roth IRA
Like a Traditional IRA, a Roth IRA is an account you can open at the brokerage or investment house of your choosing. You get to select the investments you want, and your ability to invest is limited by how high your income is. However, Roth IRAs are after-tax investments. You won’t get a tax break today like you do with a Traditional IRA or 401k. If you think you are going to be in a higher tax bracket in retirement then it makes sense to pay tax today. Once you pay tax on the funds used to invest in a Roth IRA, you never pay income tax on then again. Another big perk: you can withdraw your contributions (not your investment earnings) at any time without tax or penalty.

• Upside: tax-free retirement, can withdraw contributions at any time, ability to choose investments
• Downside: no tax break, can’t contribute as much as a 401k, may be limited if your income is very high

Tax-Free at Retirement: Roth 401k
Maybe you like your employer’s 401k plan, but you would rather pay tax today to avoid paying higher taxes during retirement. Many employers are now offering a Roth 401k option. It’s got the same high contribution limit of a regular 401k with the tax status of a Roth IRA. You pay tax today on the funds that are invested, and never again. You will have to stick with the 401k’s investment options — so you lose freedom there — but you won’t have to go through the steps of opening up an account elsewhere. Just simply change where the contributions go to with your Human Resources department.

• Upside: high contribution limit, tax-free retirement
• Downside: no tax break, must choose from plan’s investment options

Taxable Investment Accounts
A last option is to go to a brokerage firm and open up a normal investment account. You will pay taxes on the money today and in retirement as well. There’s no “retirement status” associated with the money, so you can add to it and withdraw whenever you want. You will also pay each time you trade an investment. (This could be seen as an upside or downside depending on what you think of the cost structures of other investment options.)

• Upside: ability to choose investments
• Downside: no tax break, no retirement “status”, funds can be withdrawn at any time

Retirement Plan Factors

Before abandoning your work 401k, consider these factors:

• Matching contributions: Before you abandon your 401k (or Roth 401k) consider if you get a match on your investment contribution at work. Even the poorest of investment options are worth sticking with up to the employer match, because a match is like a 100% return on your investment.
• Income taxes: Decide where you stand on taxes. Do you want a tax break today? Then a 401k or Traditional IRA is the best option for you. If you’re not concerned with that then a Roth IRA or Roth 401k is an option.
• Investment costs: A big factor is knowing how much your investments are costing you. It is much easier to see the total cost of your investments when you control the account as you do with a Traditional or Roth IRA. Employer-sponsored 401k plans have hidden administrative fees that are hard to track.

The Employee Benefit Research Institute has been studying the investment choices of over 11 million IRA investors and recently released some interesting findings about how people are using the accounts and investing their money. 

Types of IRAs

In the comparison of the traditional IRA and Roth IRA I pointed out the benefits of both because the best IRA choice for you really depends on your personal situation.  Based on the survey, more people are still opting for the traditional IRA – 67% of the investors had their money in a regular IRA. Part of the reason is that almost half of those people brought their money into the account from a tax-qualified plan using a rollover IRA.  You may fit into this category, if you left a job and wanted to take your 401k along – you had the option of rolling your money into one of these IRAs.

If you’ve chosen the Roth IRA option, you’re definitely not alone.  It was the second most popular type, with just over 23% of the investors in the study going the Roth route. The remainder of the people had their money in either a SEP (Simplified Employer Pension) or SIMPLE (Savings Incentive Match Plan for Employees) IRA.

If you do have a Roth I’d guess that as an investment you see it as more a place to invest for growth rather than capital preservation, am I right?  The study found that of the people using a Roth, a majority of them were more likely to have their money in equity mutual funds or stocks rather than bonds, money markets, or balanced funds. Let’s look some more at how people are investing their money in their IRA.

IRA Investor Allocations

I imagine you’re familiar with the concept of asset allocation, if not we’ll be covering it in the next week or so.  Basically, it’s the approach of putting your money into various types of investments so that if one asset type does poorly all your money won’t be hit by its performance.

The study broke down the type of assets that people hold in their IRAs:

• 38.5% Equities (equity mutual funds, directly held individual stocks)
• 22.3% Money (money market mutual funds, money market savings accounts, & CDs)
• 13.6% Bonds (bond mutual funds, directly held bonds)
• 12.1% Balanced Funds (balanced, lifestyle/lifecycle, target-date funds)
• 13.6 Other Assets (stable value funds, real estate, fixed & variable annuities, etc)

If you have an IRA how does this breakdown compare to your investments?  Not to say that you should use these allocations, it’s just interesting to see how you compare with lost of other investors.

IRA Risk & Age

As you get closer to depending on your investments for income during retirement, it makes sense to adjust your asset allocation to focus more on protecting your money and less on growing it.  That’s a common piece of financial advice and it seems many people are taking it into account.  According to the study, investors who are over 45 are more likely to have their money in bonds and the “other assets” category.

In contrast, if you have a long time frame until you need the money in your retirement account then it’s smart to focus on growing those funds.  If you won’t retire for 30 years and put your money into a money market fund then inflation over the coming decades will really eat into the purchasing power of your retirement money.  Based on the study, younger investors have listened to this piece of advice.  People under 45 are much more likely to have equities and balanced funds in their IRA than those over 45.

However, there are some younger investors who perhaps aren’t comfortable putting their money at higher risk by investing for growth.  About 20% of those under 35 have the majority of their investments in the money asset. 

IRA Balances & Risk

It may be that the more you have to lose, the more fearful you are of losing it.  The IRA study found that the higher the balance of an account, the lower the percentage of higher risk equities it held.  For example, IRA accounts that had balances about 10 times larger had almost 13% less of their money invested in equities.

The accounts with the most money invested (over $250K) were the most diversified and had the highest percentage of cash in bonds, money, and “other assets” categories.  They also noticed a difference between rollover IRAs and Roth IRAs.  A traditional IRA that had been rolled over from a retirement savings plan typically represented money that a person had been saving for a longer period of time.  Since the rollover IRA is usually a much bigger piece of a person’s retirement plan than a Roth, the study found the assets in a rollover IRA to be allocated in a more risk averse manner.

IRA Allocations

As I mentioned earlier, the point isn’t to suggest that your IRA investments should match those found in the EBRI study.  What I really wanted to do is to get you thinking about how your money is allocated in your IRA based on what stage you are in life.  Or if you don’t have an IRA, these are a few things to consider when you open one someday and are setting up your investment choices.

Traditional IRA

Definition: A traditional IRA is a tax-deferred retirement fund, and the contributions may be tax deductible depending on your income and tax filing status. The contributions are made on a pre-tax basis.

Income Restrictions: There are no income restrictions for the traditional IRA. Everyone can contribute to a traditional IRA, but not everyone can deduct the contributions on their taxes based on your level of income.

Withdrawals and Distributions: Withdrawals can be made starting at age 59 1/2, but they cannot be made before that without incurring a penalty. Distributions are required to be made at 70 1/2 years old. This is the FAQ from the IRS about required minimum distributions.

Advantages: The advantages all depend on how much you plan on being worth when you are in your retirement years. If you think that you will have more taxable income during your working years or you make too much money to qualify for a Roth IRA, then a traditional IRA is the right choice for you. The biggest advantage is that you can reduce your taxable income during your working years.

Disadvantages: If you are a great saver, and your IRA distributions end up becoming higher than the income in your working years, then you could end up spending more in taxes during retirement than the money you saved in taxes from your contributions.

Roth IRA

Definition: A Roth IRA is a tax-exempt retirement fund, and contributions are made with after-tax income. Contributions are not tax deductible, but the distributions in retirement are tax free.

Income Restrictions: Single tax filers cannot earn a gross income of more than $100,000 and married tax filers cannot earn more than $169,000 in order to contribute the maximum amount. Married couples making $169,000 and $179,000 can contribute a reduced amount to a Roth and an income over $179,000 means they cannot put any money into a Roth. The range where you can contribute a portion of the maximum to your Roth is called the phase out limit and for a single person it’s $107,000 to $122,000. A single person making over $122,000 can’t put any money into a Roth.

Withdrawals and Minimum Distributions: Like the traditional IRA, the minimum age to start withdrawing funds is 59 and a 1/2 years old. The principal amount can be withdrawn at any time, if you take out earnings early you will incur a steep penalty. The Roth has no minimum distribution requirements.

Advantages: The biggest advantage is not worrying about taxes during retirement. You pay income tax on the money when you earn it but don’t owe any taxes when you take distributions. If your money has been in a Roth for decades it’s hopefully been growing as the value of your investments increase. When you sell those investments you won’t have to pay taxes on your distributions so you aren’t taxed on that growth. If you will earn more in retirement distributions than you do during your working years, then the Roth IRA is for you. Also, not being required to make minimum withdrawals is a very nice thing.

Disadvantage: Contributions are not tax deferred so you don’t lower your income taxes for the year you make the contribution. Not everyone qualifies for the Roth IRA, so high-income earners don’t have the option of opening one.

Traditional IRA or Roth IRA? Not only should you calculate how much income you think you’ll have in retirement vs today, you also have to consider how tax laws will change over time.  It’s hard to know what the tax code will look like decades from now when it’s time for you to retire.  There’s been a lot of talk about tax reform lately but no one really knows when or if it will happen.

Some people think that taxes will inevitably be higher across the board in the future to help fund social programs like Social Security, Medicaid, and Medicare.  Others believe that the US government will keep tax rates relatively low and won’t adopt the high tax rates that many European countries use.

Opening an IRA

Whichever you decide, be sure to talk with your financial advisor about the advantages and disadvantages before you open an account.

Below are a few good places to open an IRA:

• Vanguard
• Etrade
• TradeKing

The popularity of the Roth IRA and the large numbers of Roth conversions, led Congress to apply some of the Roth rules to the regular 401k. The new rules mean that it is possible to enjoy the higher contribution limits of the 401k, while also taking advantage of the tax benefits of a Roth IRA. It is also worth noting that, unlike the Roth IRA, there is no income limitation on eligibility to contribute to a Roth 401K.

Roth 401k and Traditional 401k Tax Differences

The biggest difference between a Roth 401k and a traditional 401k is the way taxes are handled. Contribution limits are the same for both types of 401k: $16,500 for 2011, and an addition catch-up option of $5,500 for those 50 and older. And, of course, it is possible to have retirement contributions made automatically through your employer if you wish.

Contributions: When you make your contribution to a 401k, the way it is taxed now depends on whether or not you have a Roth option.

• A traditional 401k contribution is made with pre-tax dollars. This means that you are getting a tax deduction now. You don’t pay taxes on the income that you contribute. This lowers your taxable income, and can save you money immediately, since your money grows tax deferred.
• A Roth 401k contribution is made with after tax dollars. You do not get an immediate tax benefit for making a contribution to your Roth 401k, and you will have to pay taxes on that income now, but your contributions grow tax free.

Withdrawals: Later on, you will start taking money out of your account, which will be taxed depending on the type of 401k that you have.

• Because you have not paid income taxes on your contributions to a traditional 401k, you will have to pay taxes on the withdrawals. Any withdrawals that you make during a year will be taxed as regular income.
• With a Roth 401k, you do not have to pay taxes on your withdrawals. You have already paid taxes on the income you used for your contributions, so your money grows tax free, and your withdrawals are not taxed, no matter your income bracket.

Which is Better – Roth 401k or Traditional?

Like so many decisions in personal finance the answer is “it depends”. Many financial experts recommend that you base your decision on what you think is likely to happen later on down the road with your income.

Roth 401k
If you are in a low income bracket right now, and you expect that you will retire into a higher income tax bracket, it might be worth it to contribute to a Roth 401k. This way, you will pay lower taxes on the income you use for your contributions, and when you are in a higher bracket during retirement, you won’t have to pay federal taxes on the withdrawals.

If you contribute to a traditional 401k now, and your income increases during retirement, you will have to pay higher taxes since you will be paying on withdrawals.

Traditional 401k
On the other hand, if you think that you will be in a lower income bracket at retirement, it might be worth it to contribute to a traditional 401k, since you can defer paying taxes on the money.

One other thing to keep in mind is that tax policies can change over time.  If you think tax rates will remain relatively steady then it doesn’t much impact the income logic discussed above.  However, if you think tax rates will be much higher in the future then a Roth 401k could make more sense. 

It’s kind of frustrating that you have to speculate about the future and make your decision based on a best guess but that’s the way a lot of things work in personal finance.  Don’t let the decision making process hold you up from getting started.  Regardless of whether you’re investing for retirement with a Traditional or Roth 401k it’s better to be putting some money away than none at all.

Some years the contribution limits don’t change, the ones released by the IRS a few months ago don’t have a cost of living increase.

2011 Contribution Limits for Traditional and Roth IRAs
For tax year 2011, you can still contribute $5,000 to your IRA if you under the age of 50. If you are older than 50, you can make an extra “catch up” contribution of $1,000, bringing your total to $6,000 for the year.

It is important to note that you do not get to make a $5,000 contribution to each type of IRA. Instead, the limit applies to your combined IRA contributions. So, if you put $3,000 in your Roth IRA, you cannot put more than $2,000 in your Traditional IRA. You can, however, have a separate IRA set-up for your spouse. If you are married, you can each have an IRA in your name, which allows you to make a total household contribution of $10,000 ($12,000 if you are both over 50) for the year. If you have a stay at home spouse, it is possible to make contributions to an IRA in his or her name; this type of arrangement is often referred to as a spousal IRA.

SEP and SIMPLE plans have not changed for 2011. SEP minimum compensation remains at $550 and the maximum remains at $245,000. SIMPLE contributions remain the same at $11,500 with a catch up for those 50 and older of $2,500.

You can make 2010 tax year contributions to your IRAs until April 15, 2011 as long as you specify which tax year the contribution should be counted toward.

Phaseouts for IRA Contributions
There are phaseouts for Roth and Traditional IRA contributions. With a Roth IRA, you can only contribute if you meet certain income requirements. With a Traditional IRA, your ability to take a deduction phases out with a certain income. Phaseouts have actually changed a little bit, so it is important to be aware of them:

• Traditional IRA: Phaseout begins at $56,000 for those filing with single status, and the deduction disappears at $66,000. For those married filing jointly, the phaseout starts at $90,000 and completes at $110,000.
• Roth IRA: Phaseout begins at $107,000 for single filers, and contribution phaseout completes at $122,000. For married filing jointly, contribution limits begin falling at $169,000 and no more contributions can be made at $179,000.

You can get more information about contribution limits and phaseouts at the IRS web site.

Traditional IRA vs. Roth IRA
An IRA is a good idea, since it provides tax advantaged retirement savings. This allows you to maximize your money in a way that can’t always be done with regular investment accounts that do not have special advantages. The main difference between Traditional IRAs vs Roth IRAs are the tax advantages.

With a Traditional IRA, the money you contribute is considered pre-tax. This means that your contribution lowers your taxable income, and can help you reduce the amount you pay in taxes now. However, when you withdraw the funds in later years, you have to pay taxes on the amount you withdraw.

Roth IRA contributions are made with after tax dollars. They don’t lower your taxable income right now, but your earnings are tax free. Later on, when you withdraw money from your Roth IRA, you will not have to pay taxes on the distributions.

However, it is important to remember that although you’re not making payments a reverse mortgage is a loan and at some point it will have to be paid back — along with fees and interest.

How Does a Reverse Mortgage Work?

Applying for a reverse mortgage is similar to getting other types of loans, but your credit and income don’t matter because you’re borrowing against home equity.  Lenders look at your age, interest rates, and how much equity you have in the home (as well as the market value of the home) when considering applications for a reverse mortgage. Since the reverse mortgage is intended primarily for retirees, income levels are a moot point.

A mortgage lender will get an appraisal to determine the market value of your home and how much you are eligible to borrow.  Then you can decide how you want to receive your money; as a single lump sum, as a line of credit, or in the form of regular payments.

Reverse Mortgage Payments

How you elect to receive the money depends on what you use the money for. Some people take out a reverse mortgage and use a lump sum to pay some major expense. Others are looking to make up for a shortfall in their monthly cash flow, and choose to receive payments monthly.

Reverse Mortgage Fees

Lenders will charge you an origination fee, mortgage insurance, and closing costs to process a reverse mortgage.  This can be a lot to pay if you’re on fixed income so many lenders will let you roll these costs into the loan. When the Federal Housing Administration (FHA) defined the reverse mortgage product they created a cap on the origination fee. The fee can’t be more 2% of the first $200,000 and 1% thereafter, with an overall cap of $6000.

Reverse Mortgage Eligibility

Since the FHA insures reverse mortgages, they set following criteria about who qualifies for a reverse mortgage.  You must:

• Be at least 62 years old. (Some lenders will offer non-FHA reverse mortgages to those who are younger.)
• Own the property, or have a small balance remaining on your original mortgage.
• Have no federal debt delinquencies.
• Meet with a counselor about the reverse mortgage.

Repaying a Reverse Mortgage

As long as you live in your home as your primary residence, you do not need to make payments on your reverse mortgage (although you can). Once you have not been living in the home for a year, though, the reverse mortgage comes due. For many, this happens when long-term care is needed, or upon death.

The reverse mortgage is repaid with funds from the sale of the home. This is why the market value of the home, and the equity in the home, are such important considerations when getting a reverse mortgage. Unless the estate or heirs pay of the reverse mortgage, the home will have to be sold to repay the obligation.

Reverse Mortgage Insurance

It is important to note that a FHA reverse mortgage cannot be repaid for more than the amount of the home’s market value. This means that if home values plunge after the reverse mortgage is made, the lender can only take the amount the home is now worth — even if more is owed on the home.  This is why you’re required to buy mortgage insurance on a reverse mortgage.

The FHa offers two different types of reverse mortgages, the Home Equity Conversion Mortgage (HECM) and the HECM Saver.  The HECM Saver reduces the amount of mortgage insurance you pay up front at closing but also puts a lower limit on the amount you can borrow relative to the value of your home.

Bottom Line

It is important to research the pros and cons of reverse mortgages before making the decision to borrow against your home.  You should read more about the benefits of reverse mortgages for seniors as well as reverse mortgage disadvantages.

Retiring Overseas

Retiring abroad is viewed as a way of maintaining one’s social standing on a reduced income, or possibly even improving it. The stereotypical view of a retired western expat is one of an older person on a state pension who lives a decadent beachfront lifestyle amidst the relative poverty of the new country he or she has settled in. Typically these countries are located in Southeast Asia or Latin America.

Stretching Your Retirement Money?

The information you see on the internet and in bookstores on places to retire is going to play this image up as much as possible. You are going to be shown “sample budgets” of a “typical” couple living on less than US$1500 per month on the beach, with servants, a car, and living on a steady diet of meals in finer restaurants.  When you’re trying to decide where to retire, keep in mind many of these examples of this “new retirement” are exaggerations.

Retirement Living Abroad

The only real way to improve your standard of living dramatically on a small budget is to move to an impoverished country. Belize, Panama, Nicaragua are touted as the best places to retire for those with little savings but guaranteed incomes and a penchant for beachfront living.

What you aren’t being told is that you’re going to have pay for your own private health care, there’s a bit of paperwork you’ll have to fill out to qualify for a retirement visa, and these countries have high crime rates and often poor infrastructure. Poor infrastructure can mean anything from bad roads to intermittent electricity to run down hospitals.

Below is a brief retirement guide that I think you should follow in order to have a successful experience abroad in retirement. These guidelines are very broad, but if followed they can mean the difference between a miserable time overseas, and spending your retirement in peace and bliss:

1. Visit first. This might seem like common sense, but I don’t mean that you should merely visit your would-be retirement destination for a week during ideal weather. You should be intimately familiar with the country you plan to retire to.

This means being well aware of its weather regardless of the season. It means knowing what the country is like during growth and recession. Is it too humid in the summer? Is it politically stable after market crash? These are things you should know before you move.

2. Make sure your spouse/partner is on board. Which of you really wants to move overseas? In my experience living abroad, the happiest people are those who have a happy significant other. A couple is a team and there’s nothing more stressful than having your fellow team member not on board with something as significant as a move abroad.

A new environment combined with two people spending more time together because neither person works any longer can add to the strife. Learn to live with your significant other in retirement before making a move abroad.

3. Keep your home country’s health care. Many view moving abroad as a way to save on healthcare, particularly if you are American. It is true that health care in many countries, particularly in the developing world is comparatively inexpensive. However, to get this health care you generally have to have private health insurance and this health insurance is not guaranteed.

Your coverage can be dropped if you become too expensive, which is certainly an issue if you have a chronic illness and need long term hospitalization. By keeping your government backed healthcare going, you have the alternative of moving back home for treatment. Government backed health care, specifically Medicare, can’t be taken away no matter how expensive your treatment is. Private health care can and will be if your treatment gets too pricey.

4. Be passable with the local language. Again it seems like common sense but beyond making it easier to order from a menu, it allows you to save money routinely. The best offers are available to locals; in contrast the worst and most expensive offers are usually made to English speaking tourists.

Knowing the language will allow you to be aware of local rules and regulations which will help you avoid any legal entanglements and issues with local law enforcement.

5. Keep a home address. I’m not saying keep your old house, which may be too expensive to accomplish. I mean keep an old address for bills and to maintain a relationship with a bank. If you retire abroad you should keep the majority of your liquid assets in your home country rather than in your retirement destination. Why is this? Currency devaluations are a common occurrence overseas and local banks are rarely government insured.

One problem you may face is that many American banks don’t like it when their customers are living overseas and keeping a home address to give the facade that you are still living at home. Typically it is not illegal to maintain this illusion, but banks do not wish to be the victims of money laundered transfers. 

In this age of increased government scrutiny of overseas travel and international money transfers, banks may try to close accounts of people they believe are no longer living locally. This is certainly an enormous issue for any expat.

Retirement Planning

These five tips are really just the beginning of the planning you’ll need to do if you’d like to retire overseas. Unfortunately, no amount of preparation can account for every eventuality of retiring abroad. There will always be surprises, some good, some bad.

But a dollop of common sense combined with a well thought out plan can help you achieve what you want in your new overseas life. I hope these tips serve as a beginning of your plan!

About the author: Rick Todd writes at Expat Investing where he discusses such topics as whether retiring abroad is right for you and if you can afford to live abroad on social security alone.

Tax Deferred Contributions vs Tax Exempt Earnings

With a traditional IRA contributions are tax-deferred, meaning that you don’t pay income taxes on the money you put in until you take the money out.  With Roth IRA contributions on the other hand, you pay income taxes on the money you earn and put into the account but the earnings when you take money out are tax free.

IRA Minimum Distribution

Both the traditional IRA and Roth IRA require you to wait until 59 1/2 to start withdrawing your earnings without penalties. With the traditional IRA you have to start taking distributions at 70 1/2 years old but the Roth has no minimum distribution requirements.  The government doesn’t really care when you take out your earnings for a Roth since they don’t see any tax revenue from it but with a traditional IRA they want to make sure you don’t delay your IRA distributions (and their tax revenue) too long.

Traditional IRA

One of the advantages of the traditional IRA is that you can reduce your taxable income during your working years.  Since that income isn’t taxed right away, you have more to invest and the hopes are it will grow for the next several decades until you reach retirement age.

Of course the downside to the IRA is that you are hit with a big tax bill in retirement when you withdraw money from your account.  If you anticipate being in a lower tax bracket when you retire than when in your working years then you would pay less taxes.  Keep in mind that no one knows what the tax laws will look like decades from now.

Roth IRA

One of biggest advantages of a Roth IRA is that you only pay tax on the contributions, the earnings are tax free.  So if you invest your money wisely and it grows by leaps and bounds over the next several decades then you’ll have some nice IRA distributions that aren’t taxed.

Another benefit to a Roth IRA is that you can withdraw any principal you’ve paid in prior to retirement without a penalty.  Since an IRA is an “Individual Retirement Account”, it’s best to save the money for retirement when you have have a working wage coming in.  However, in an extreme circumstance it’s nice to know you could access the Roth IRA contributions if needed.  This does not include the earnings, if you withdraw those early you will pay a penalty.

The obvious downside to a Roth IRA is that the money you contribute is not pre-tax so you don’t lower your income taxes in the year you put money in.  Another potential issue with a Roth IRA is that it does have maximum income limitations so so high-income earners don’t have the option of opening one.

Opening an IRA

Deciding between a regular IRA and Roth IRA should not become a retirement investing roadblock.  Don’t let indecision hold you back from getting started investing for your retirement years.  Just because you open a Roth IRA this year and fund it doesn’t mean you can’t contribute to a traditional IRA instead next year.  The most important thing is to get started putting some money away!

Investing More in Your 401k

Depending on whether you have a traditional 401k or a Roth 401k, the immediate tax implications may differ, but the long term growth effect of increasing your 401k contributions can be pretty big over time. Although the government has established 401k contribution limits, many of us never come close to investing that much into our retirement account every year.  So how can we talk ourselves into saving more for retirement?

Automatic Savings Plans

Our 401k plan has an optional feature called Automatic Savings Increases that lets us increase the amount we invest into our 401 k automatically each year.  As you can see below, I get to choose what percentage it increases each year, what the maximum contribution percentage is, and what day in the year the increase goes into effect. Our 401k investments are made out of my paycheck so the actual first day of the increase will depend on when I get paid, which is the first and middle of each month.

Of course you can opt into or out of these increases, when I signed up for my 401k account I decided choosing to participate would be a good idea.

Many companies, mine included, give annual performance reviews and based on your results give you a certain percentage of salary increase.  My thoughts were that I’d increase my 401k contributions as my salary went up.  The only problem is that life gets busy and I forgot to change my contribution percentage last summer when my salary went up.

The good news is that I had signed up for the Automatic Savings Increase plan when I started the job so my contribution percentage automatically went up last year.  Even though you may forget to contribute more, you’ll likely remember once the automatic increase kicks in and the amount of your paycheck changes; that’s what happened to me.  However, if you time your contribution increases to correspond with annual pay increases then the overall impact to your cash flow should be minimized.