Sam also noticed the great deal presented in 5/1 ARMs. I was paid $900 after all said and done when I refi’d to a 5/1 ARM at 2.625% last year. The rate is somewhat lower again now. I’m holding out for 2.125% for a half-point reduction from my current rate and extending my fixed rate period by one more year.

*****

The cyclically-adjusted P/E ratio (PE10 or Shiller PE) at Monevator

If you hesitate to invest in the stock market because the P/E 10 is still high relative to its historical levels, it probably means you already reached your risk tolerance. P/E 10 may come down, but a lower P/E 10 doesn’t necessarily mean a lower price. A lower P/E 10 may be achieved by a higher P and an even higher E. A lower P/E 10 does no good if you have to buy at a higher price.

*****

Is It Safer to Use Multiple Fund Companies? by Mike Piper at Oblivious Investor

Safer? No; one is just as safe as many. Better service, yes.

*****

Medicine — Still a Pathway To The 1%! by Jim Dahle aka The White Coat Investor at I Am 1 Percent

If the goal is to get into the 1%, I think studying and practicing medicine is too hard. Finance, law, and working for Facebook are probably much easier. They don’t require that many years of schooling and that heavy borrowing.

*****

The Cost of Living is Too High These Days, Waaah, Waaah! at Mr. Money Mustache

The cost of living definitely depends on how you live.

*****

The Asymmetric Value of Delaying Social Security Benefits As The Ultimate Hedge by Michael Kitces at Nerd’s Eye View

I agree delaying Social Security would be the ultimate hedge for longevity, high inflation, and low investment returns. It also opens up more years for converting tax deferred retirement accounts to Roth at a low tax rates.

*****

In Defense of Spirit Airlines’ $100 Bag Fee by Jordan Weissmann at The Atlantic

Spirit Air takes an unbundled approach to pricing most famously adopted by Ryanair in Europe. Despite gripes from some customers, Ryanair is doing well. Customers are the ultimate arbiter in the market.

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When a kid works for pay, a parent can open a Roth IRA for the kid and fund the Roth IRA with the parent’s money, up to the kid’s earned income. However, an IRA by definition has only one owner; there’s no joint IRA. Because the kid under 18 can’t open the account him- or herself, an adult has to do it as the custodian.

This type of account is called a custodial IRA. The kid is the owner. The adult is the custodian.

A custodial IRA is different from a UGMA/UTMA account. A custodial IRA is tax free if you choose the  Roth flavor. A UGMA/UTMA account is still taxable. But funding a custodial IRA is limited to the kid’s earned income; a UGMA/UTMA account doesn’t have such requirement.

Not all places offer a custodial IRA. For instance Fidelity will not open an IRA unless the owner is at least 18. Maybe the market is too small. Many kids work but their parents aren’t willing to fund a Roth IRA for the kids when the parents themselves don’t save enough for their own retirement.

If you find a place that offers a custodial IRA, the next hurdle is the minimum amount required for opening an IRA and the fees charged on small accounts. The kid’s earned income may be very small. That’s another reason financial institutions aren’t that interested in this type of accounts.

Vanguard offers a custodial IRA but the minimum amount required to open one is $1,000.

Fortunately some places have a long-term view. They make it easy for kids and their parents because they understand a relationship entered into when the kids are young will likely last when the kids become adults.

Charles Schwab, for example, offers a custodial IRA with a $100 minimum and no maintenance fees. You can invest in low cost Schwab index funds which require only $100 minimum and no purchase fees. A kid’s IRA at Schwab can have a diversified portfolio with very little money.

If your kids work, seize the opportunity to open a custodial Roth IRA for them.

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Clark Howard, a consumer advocate and personal finance guru on radio, also says now it’s a great time to buy a home, either to live in or as a rental property.

So far all my investments are in stocks and bonds. I’m not sure if the home I live in counts as an investment in real estate. Suppose it doesn’t, should I diversify my investments with a rental property?

Diversification

On one hand, more diversification is good. A rental property receives a stream of rent payments. Allowed depreciation makes the rent income more tax efficient. If the value of the property appreciates when I sell, that’s another source of income. All these probably have low correlation with stocks and bonds. It seems my investments would be more diversified if I add rental real estate.

On the other hand, I will have just one property, in one specific neighborhood, in one specific part of the country. It would be very much like buying a single stock — be it Apple, Exxon Mobil, or Wal-Mart. It smacks of speculation to me. After being bitten by speculation some years ago, I swore I would never do that again. It seems adding a rental property would actually make my investments less diversified.

I’m not sure if it’s actually more diversification or less diversification if I add a rental property to the mix.

Liquidity

A rental property is clearly not as liquid as stocks and bonds. If I want to be out of some mutual funds or ETFs, all it takes is a few mouse clicks. I would get the true value less a negligible amount. If I ever want to be out of a rental property, it would take so much longer and cost so much more.

That’s also a reason an illiquid investment such as a rental property can give a good return because it has to sell at a lower price multiple in order to attract buyers.

I’m tolerant of illiquidity to a certain extent. I invest in I Bonds, muni bonds and CDs instead of Treasuries when I trade illiquidity for a higher return. But we are talking about a magnitude of difference here. Compared to a rental property, I Bonds, muni bonds and CDs are super liquid.

Carrying Costs

Besides the initial investment, say I buy a rental property outright, I will still have carrying costs such as property tax, insurance, and maintenance, whether the rent is able to cover them or not. With stocks and bonds, the worst case would be that they don’t pay me anything; I will never be cash flow negative. Not so with rental real estate.

Property Management

How do I find tenants, collect rent and manage the property when I’m far away from Las Vegas? My co-worker said don’t worry, a property manager will take care of all those for you. I just sit back, relax, and collect rents (after paying a cut to the property manager).

I somehow doubt it would be that easy. I imagine many decisions will still have to come to me. Investments in stocks and bonds don’t require much involvement at all. Dividends and interest come automatically without me lifting a finger.  If I’m away for a month, nothing would happen. I like that.

I think adding a rental property would add stress to my life. With a busy work schedule, I don’t need any more stress. It could be very profitable though. I know people who retired in their early 40s because they made a lot of money from rental properties. From listening to Clark Howard, I got the impression that investing in rental property is quite widespread. I tried to look for census data for what percent of the population owns a rental property. I haven’t found any. Does anyone know?

Maybe it’s a great opportunity. I will leave it to others.

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“Excessive caution, he told me in a recent interview, means we buy long-term security at the expense of giving up many things we’d like to do today. We leave estates that are larger than planned and feel remorse for experiences we’ve missed.”

*****

Former Oregon retirement plan manager jailed in Idaho on fraud charges by AP

Matthew Hutcheson carried the flag about 401k fees being too high. He’s also a co-founder of BrightScope, a company that rates 401k plans. I mentioned his interview on public radio in which he said 90% or more of all 401k plans pay 3-3.5% in fees. Now he allegedly misappropriated $5 million of pension funds he’s trusted with. There’s a name for this phenomenon. The name escapes me though.

*****

Can a “Run on the Bank” Occur with Mutual Funds? by Mike Piper at Oblivious Investor

I answered “yes.” You?

*****

The Tax Code Is a Complicated, Horrible Mess Because We Like It That Way by Derek Thompson at The Atlantic

I’m telling you the public is duped. By giving small carrots to the middle class, the politicians hand the vast majority of the tax breaks to the rich. Just look at this chart for who gains most from tax breaks. Assuming the numbers in the chart are accurate, by my tally, top 1% get 21% of the tax breaks; top 20% get 64% of the tax breaks.

It’s time to give up those small carrots.

*****

How Does Pension Income Splitting Work? by Tom Drake at Canadian Finance Blog

That’s Canada. They only allow splitting income from retirement account withdrawals and annuities. Here in the U.S. all sources of income can be split between spouses. It’s called married filing jointly. It also created a big mess called marriage penalty. It’s another thing that benefits the rich more than others.

*****

One Goal, One Portfolio by Kevin at Kevin On Investing

I agree that you should view all your accounts for the same goal as one portfolio: 401k, IRA, taxable account for retirement. What if you have two or three goals? Still one portfolio because money is fungible? Or separate portfolios with separate asset allocations?

*****

The Difference Between Active and Passive Investing by Matthew Amster-Burton at MintLife

I’m like Hailey. I stay the course most of the time but I’m also not afraid to deviate a little bit to the left or to the right given the right occasions. Not a purist, that’s for sure.

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HSA Contribution Limits

You can only contribute to an HSA if you have a High Deductible Health Plan (HDHP).

HDHP Qualification

The IRS also defines what qualifies as an HDHP. For 2013, an HDHP with individual coverage must have at least $1,200 in annual deductible and no more than $6,250 in annual out-of-pocket expenses. For family coverage, the numbers are minimum $2,400 in annual deductible and $12,500 in annual out-of-pocket expenses.

HSA vs. FSA

I chose an HDHP and HSA for the first time this year. So far so good. I like the flexibility provided by the HSA over the FSA, which I used in the past. No more guesses on how much I should put in every year.

I’m using the HSA provider my employer chose because I get to save a bit of FICA tax if I contribute by payroll deduction. After the year is over, I’m planning to write a check and transfer the balance to my own HSA.

Reference: IRS Revenue Procedure 2012-26

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Most public sector employees still get a pension. This often brings envy. People who don’t get a pension and don’t get enough from their 401k’s are increasingly unwilling to pay those who do.

It also leads to some people saying the 401k system is a failed experiment and that we are better off with a pension. A recent New York Times article by Joe Norcera quoted Teresa Ghilarducci [*], an economist at The New School as saying

[People's] retirement plan is faith based. They have faith that it will somehow work out. The 401(k) is a failed experiment. It is time to rethink it.

Why can’t 401k and IRAs provide as much retirement income as a pension? There are many reasons such as

• Not all companies offer a 401k (not all companies offered a pension in the past either)
• Expensive funds and hidden fees in 401k plans (see how to uncover hidden fees in your plan)
• Poor stock market returns since 2000
• People don’t understand investing

These are all true. The biggest reason though, I would say, is that people don’t want 401k and IRAs to provide as much retirement income as a pension once did. In other words, 401k and IRAs don’t succeed because people don’t want them to succeed.

I came to this conclusion from reading Vanguard’s report on the 401k-type plans it manages: How America Saves. It shows in aggregate how much people contributed to their 401k plans, how much people accumulated in their 401k plan accounts, how much they traded in their accounts, etc. etc. Vanguard publishes this report every year. The data in the linked report are as of 12/31/2010. A new report will probably come out in a month or so but since the numbers don’t change that much from year to year, the current report is just as revealing.

The Vanguard report is 92 pages long. I highlight these interesting statistics (most of them are found on page 23):

• 32% of employees don’t contribute
• 59% of employees younger than 25 don’t contribute
• 27% of employees older than 55 don’t contribute
• 12% of employees with incomes of greater than $100,000 don’t contribute
• Median employee contribution rate is 6%
• 21% of employees contribute more than 10%
• 9% of employees contribute the maximum allowed by law

Remember the participants covered by the Vanguard report (a) have a 401k plan; and (b) have low cost funds from Vanguard. The picture is very clear. If people don’t contribute to their 401k’s or if they don’t contribute enough, of course they are not going to have enough in their accounts to cover their retirement.

How were pension plans able to do better? I once worked in the employee benefits department at a large employer with a pension plan. The annual funding to the pension plan often came out to about 20% of payroll. To the employer, whether it’s cash salary or pension contributions, it’s all money coming out of its pocket as employee compensation costs. The company was basically automatically putting 20 / 120 = 17% of an employee’s compensation into the pension plan. There wasn’t any choice. That 17% went in no matter what. It was forced savings.

When competition forced the employer to freeze the pension plan, all employees basically got a pay cut. With a 3% 401k match, they are now paid 103 instead of 120. Instead of taking the 17 / 120 = 14% pay cut across the board and still saving the same percentage of the new total compensation for retirement, employees took a large part of the pay cut directly from retirement savings. After saving 6% in a 401k and receiving a 3% match, their cash salary is down from 100 to 94, but retirement savings are cut more than half from 20 to 9. When you cut your retirement savings in half, of course your 401k won’t be able to pay as much as a pension would.

Why, when faced with a 14% pay cut would people take the majority of the cut directly from retirement savings? People clearly expressed a preference for more cash today. If the employer didn’t have a pension plan and it just paid 120 to the employees as cash, the employees probably wouldn’t have contributed 20 toward retirement anyway. In other words the old pension setup forced the employees to save for retirement more than they wanted to.

Is the preference for cash today over retirement in the future bad? I’m not the one to judge. I subscribe to the philosophy of "live and let live." If people want to spend more when they are young and spend less when they are old, what’s wrong with that? Why should an employer be able to force them to save for retirement more than they wanted to?

Now, back to the question in the title. How do you make your 401k pay as much as a pension? One word: contribute. It takes about 15-20% of your pay to get to the level a typical pension plan once paid. If you want to achieve the same level of retirement income, you will need to target the contributions at 15-20% of your pay, counting your employer match.

The Vanguard report says that including employer match, employees with an income between $50k and $100k should save at least 12% of income; 15% of income if the income is over $100k. Given the uncertainty over Social Security and salary growth, I would bump these numbers up by a few percentage points.

Then again, maybe people don’t want to save that much for retirement. They have other plans for their money. Then there’s nothing wrong with low savings numbers in 401k accounts and IRAs. They are low because people want them to be low.

Next time you hear people used to have a pension, think people used to save 15-20% of their pay. Nothing stops people from doing so today. That is, unless people don’t want to.

* Teresa Ghilarducci appeared in a short interview with Tess Vigeland on public radio program Marketplace: The 401(k): A failed experiment? I don’t agree with her, for reasons stated above.

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If you dread another tax form, relax. Form 5500-EZ is very easy to do. My plan is with Fidelity. I received my 2011 Retirement Plan Annual Valuation Statement from Fidelity last week. With the information from Fidelity, I completed Form 5500-EZ in less than 5 minutes.

Here’s a filled-out example (click on it if you want to see page 2):

Besides the usual Tax ID, name, address and phone number entries, Form 5500-EZ asks about the plan’s assets at beginning of the year, at end of the year, and the total contributions during the year. As far as the numbers go, that’s it, very simple. I get those numbers from the annual valuation statement from Fidelity.

Fidelity’s annual valuation statement doesn’t break out the total contributions by employer and employees whereas Form 5500-EZ wants the employer and employee contributions separately. I get an easy out because all my contributions are employer contributions. If you do a mix of employer and employee contributions, you can find the number for the employer contributions on your tax return: Form 1040 line 28 “Self-employed SEP, SIMPLE, and qualified plans”. Subtract the employer contributions from the total contributions to get the number for the employee contributions.

If you are filling out Form 5500-EZ for the first time, you have to look up a few codes in the Form 5500-EZ Instructions. The second time you just copy from the previous year. For my plan:

Line 2d Business code:

• 519100 = Other Information Services (including news syndicates, libraries, internet publishing & broadcasting)

Line 8 List of Plan Characteristics:

• 2E = Profit-sharing
• 2J = Section 401(k) feature
• 2R = Participant-directed brokerage accounts provided as an investment option under the plan
• 2T = Total or partial participant-directed account plan – Plan uses default investment account for participants who fail to direct assets in their account
• 3B = Plan covering self-employed individuals
• 3D = Pre-approved pension plan – A master, prototype, or volume submitter plan that is the subject of a favorable opinion or advisory letter from the IRS.

That’s it. Form 5500-EZ is really easy.

If you have a SEP-IRA and you worry about Solo 401k being too difficult to do, don’t. Even if you have to file this extra form once a year, it only takes 5 minutes. The biggest advantage of a Solo 401k is that it allows employee contributions in addition to employer contributions whereas the SEP only allows employer contributions. This is more important if your self-employment income is under $200k or so. If you are not earning big bucks from self-employment, Solo 401k is the way to go. If you are earning big bucks from self-employment, Solo 401k still helps you with Backdoor Roth.

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I paid extra with a tax extension. Then I allocated $5,000 from my tax refund to savings bonds. I received $5,000 paper I Bonds about four weeks later. Sweet! Here’s the proof:

If you haven’t bought your quota of I Bonds at TreasuryDirect, this month is the last chance to get the 3.06% rate for the first six months. If you buy in May the rate will be 2.2%.

I have another piece of good news. After pausing for over a year, Frank made a new post to his blog Bad Money Advice: Are Timeshares a Good Idea? Although the answer is obvious, I’m still glad to see Frank’s return to blogging. I hope he’s not just teasing us.

*****

A reader asked Mike at Oblivious Investor How Much Do I Need to Save Per Year? Surprisingly such a simple question has no clear answer. There is no answer because there are simply too many unknowns. How will one’s income grow over the years? What invest returns will the market deliver? No one knows, but we still need to make a decision on how much to save today.

The old rule from The Richest Man in Babylon said save 10% of your income. That was when interest rates were high. My answer would be: save 15%; invest well; be flexible and live with whatever you end up having.

*****

Scott Burns at AssetBuilder wrote Reverse Mortgages: Their Time Has Come. I agree. A reverse mortgage can be thought of as selling the home and using the proceeds to buy an annuity plus a call option on residential real estate. If the real estate value increases more than projected, there can be excess value left at death. If the value doesn’t go up as much, the bank can’t come after you for the difference. However, in many cases, I think selling outright and buying a life annuity would be more straightforward than a reverse mortgage, especially when the home is larger than what the retirees need.

*****

I Bonds are now a free lunch for everyone because the rate can’t go below inflation. White Coat Investor tell us about another free lunch in The G Fund, a Free Lunch. This G Fund free lunch is only limited to federal government employees and members of the military.

You know what they say about free lunches. There aren’t free lunches. In I Bonds, taxpayers who don’t buy I Bonds are paying for the extra interest, although they are free to buy I Bonds if you they want to. In the G Fund, other taxpayers who aren’t allowed to invest in the G Fund are paying for it. If you have access to a free lunch, enjoy!

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It’s a difficult topic because there can be many variations. Employers issuing the RSUs don’t help because they are afraid of liabilities. They just say "consult your tax advisor" as if everyone has one. Tax software doesn’t make it easy either. Although there are many variations, the software tends to go by just one. If your situation fits it, you may be able to muddle through. If it doesn’t, the software confuses you more than it helps you because your situation doesn’t match what it thinks you have.

For the longest time I only addressed the issue generically. I refused to work as free tech support for the software companies. If you paid for the software, they should help you with how to use it. Now I give up. I realize people are looking for step-by-step help and the software companies aren’t providing it. Although this may be a little late for this year, there is always next year.

The following is a sequence of screenshots taken from TurboTax Online Premier edition. If you use the installed software or a different edition, your screens may be different but similar. I show TurboTax only because it has the largest market share.

In this post I will start with the most straight-forward case: Net Issuance. It’s probably the most common. It’s also a case TurboTax handles relatively well. I may do other variations in future posts.

In Net Issuance, the employer withholds a number of shares for taxes and gives the employee the remainder. For example suppose you have 100 shares vested but you only receive 60. You just don’t see the other 40 shares. The employer doesn’t use a broker to sell the 40 shares for taxes. It just keeps the 40 shares and puts some numbers on your W-2.

Let’s get started.

Start from Tools on the top right, under the running meter.

Click on Topic Search.

Here comes the first challenge. You won’t find RSU or Restricted Stock Units. Type "employee stock" in the search box and find "employee stock plans" in the list. Click on Go.

From the topic list, you will jump to this screen. It still says Employee stock plans, not RSU. Take a look at the More Info link before you click on Yes.

Now it shows Restricted Stock Units (RSU) as a part of Employee Stock Plans.

The next screen asks you if you sold stocks from RSU. Click on Yes if you sold. If you didn’t sell, don’t enter anything. Wait until you sold those shares you received from your RSUs.

This is just a note about some changes from the IRS. Nothing to do here.

Here TurboTax asks you if you want to take the longer, more difficult, mis-named EasyGuide or the shorter, easier way to just enter on a spreadsheet. If you enjoy the ride, let’s first take the EasyGuide recommended by TurboTax. Later you will see how easy it is with the spreadsheet.

EasyGuide

Restricted Stock Units (RSU) is listed in the middle. Choose that.

The name of the employer comes from the W-2 you entered earlier in TurboTax.

A list of things you need. Click on "See an example" for the example we will use.

Here’s the example we will use.

Vesting/Release date	2/12/2011
Vested shares	160
Closing price on vesting date	$51.61 per share
Number of shares withheld for taxes	63
Number of shares issued to the employee	97
Date sold	2/20/2011
Shares sold	97
Selling price	$51.07 per share
Net proceeds after commission	$4,933.76

On my 1099-B, Box 6 is checked and Box 8 is blank.

It does some math and then asks you about your sales expenses. Use your net proceeds number to back into the number it wants. $4,953.79 – $4,933.76 = $20.03. Why doesn’t it just ask about the net proceeds number you have on your 1099-B?

After you do the math, it shows you that your math is correct.

My 1099-B does not show a cost basis.

It’s asking you whether you sold the shares from one lot or multiple lots. We will take the simple case of one grant lot. Click on the Explain This link if you want to know more about grant lots.

But it’s talking about exercising stock options and purchasing shares. You are given RSUs. Are you confused yet?

Enter vesting information.

No splits to keep it simple.

No reinvested dividends either, to keep it simple. If you had either splits or reinvested dividends, it’s going to be more complicated.

Now it’s showing a short-term loss because the value of the shares was $51.61 per share when they were vested and the shares were sold at $51.07 per share less commission and fees. Click on the View Details button.

It explains how the numbers are calculated. $4,933.76 is the number from 1099-B. $5,006.17 is value at vesting ($51.61 per share times 97 shares). The difference is a $72.41 loss. Click on the Explain This link about compensation income.

You get this popup. So far so good.

We are done with this sale. Rinse and repeat if you have another sale.

After you are done with all investment sales, TurboTax wants to double check the value of the vested RSUs are included on your W-2. Say yes and make the numbers match.

Now do you want to see how easy it is to enter the RSU sale on a spreadsheet?

Enter On a Spreadsheet

From the "How Do Your Want to Enter Your Investment Sales" screen, choose Enter on a Spreadsheet.

Enter these

Now TurboTax offers a review. OK, we go along with it.

It was stock.

No special situations.

It’s looking for wash sales. Answer the question truthfully.

We arrive at the same investment sale summary. This is so much faster than the EasyGuide!

This should convince you that you should not use the EasyGuide to enter RSU sales. The spreadsheet method is much easier to use and understand.

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Transfer of security from First Clearing

Who’s First Clearing? I thought I was transferring from Wells Fargo Advisors.

It turns out that my account had been with First Clearing all along. First Clearing is a Wells Fargo subsidiary. Wells Fargo Advisors sets the prices and provides customer service; First Clearing actually does all the real work in buying and selling investments for the brokerage account.

It was disclosed in the account agreement I agreed to when I opened the account. I just didn’t pay as much attention at that time.

"[Wells Fargo Advisors, LLC] will act as your introducing broker and First Clearing, LLC (“FCC”) will act as the broker that will carry the Account and extend credit on any margin purchases."

In addition to doing the actual work for Wells Fargo Advisors, First Clearing also does the work for other brokers. This is similar to how Amazon sells its warehouse picking packing and shipping service to other retailers. Amazon developed expertise in running a warehouse efficiently in serving its own customers. Now it also sells that service to others.

Fidelity also has a similar arrangement. Fidelity’s clearing subsidiary is called National Financial Services. National Financial does the work for Fidelity. It also does it for others. When these clearing firms work for others, they use a generically sounding name such as First Clearing or National Financial so as not to compete with their clients’ brand.

From this article on the web, I see large discount brokers such as Charles Schwab, TD Ameritrade, and E*Trade all have their own clearing operations, but they use their own name, which means they are probably not serving other brokers. Smaller brokers such as Scottrade, TradeKing, Zecco, and OptionsHouse use a small third-party clearing firm called Penson Financial Services. Penson is publicly traded on the NASDAQ with ticker PNSN. At $0.55 per share, Penson has a market capitalization of just $15 million. That doesn’t give a whole lot of confidence.

Should you care who’s doing the work behind the scenes? I think so. You want a company that knows what they are doing and makes sufficient investment in technology and personnel.

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