Borrow from your 401(k)? Document the need

The Internal Revenue Service has issued guidance around hardship withdrawals from 401(k) plans that clarify what some observers call otherwise murky rules on hardship distributions.

The guidance came in the form of a memo to IRS employees who audit tax-qualified retirement plans such as 401(k)s on how to conduct an audit of “safe harbor” hardship withdrawals.

The guidelines don’t modify existing law, but indicate the items auditors should focus on in ensuring a plan’s legal requirements are satisfied when participants take a withdrawal.

The guidance is helpful to employers, advisers and providers such as record keepers and third-party administrators because it lays out proper steps and documentation for hardship withdrawals.

Hardship withdrawals offer participants a way to tap their retirement savings in 401(k) plans. Unlike a loan from the plan, participants don’t have to pay back funds used for a hardship withdrawal. However, they’re subject to income tax and, if the participant isn’t at least 59 ½ years old, a 10% withdrawal penalty.

Participants must prove a heavy and immediate financial need to tap the money, and that the distribution is necessary to satisfy that need.

The government wants to make sure people aren’t using the 401(k) plan as a piggy bank.

Items qualifying for hardships include expenses related to medical care, purchase of a principal residence, tuition, prevention of eviction from a principal residence, burial or funeral expenses, and repair of damages to a principal residence. The IRS requires verification that a distribution is for one of these items.

The IRS, in its new guidelines, issued Feb. 23, said during a plan audit, the review is to look for copies of “source documents, such as estimates, statements and receipts, regarding the hardship or a “summary,” in paper, electronic format or telephone records, of […]

Don’t bank on another 8-year bull-market bonanza

Today, Wall Street will celebrate the eighth anniversary of the most recent, and perhaps the most hated, cyclical bull market. It has been hated because there are those who believe the gains were fueled by the Federal Reserve’s quantitative-easing program—and therefore artificial.

Yet, the bull has charged on, making the faithful a pretty penny.

Since March 9, 2009, when the most recent bull market began, the total return on the benchmark S&P 500 index was an impressive 316%. The market has more than quadrupled in just eight years.

Over the past eight years, there hasn’t been a single year of losses and the average annual return was 14.9%. The S&P 500 is up 6.5% year to date and up more than 18% over the past 12 months, according to FactSet.

Hating this bull market and bracing for a crash, as some scary headlines had suggested over the years, would have cost investors dearly even though there were many reasons to suggest that fundamentals were shaky.

Lofty stock prices have been a key concern. Earnings growth has lagged behind the appreciation of prices, sending valuations to the highest levels since the tech boom of late 1990s.

“If you had told me at the end of 2013, after we’ve had more than 30% gain, that the market would rise another 50%, I would not have believed it. All the reasons [for it to fall instead] seemed sound at the time,” said Ben Carlson, director of institutional asset management at Ritholtz Wealth Management.

This kind of stellar performance from the market isn’t unprecedented. U.S. large-cap stocks performed even better between 1991 and 1999, when the average annual return was 21.4%.

The decade between 1999 and 2009, in terms of returns was one of the weakest, where […]

Why a Savings Account Is Your Riskiest Investment

Even if you’re new to investing, you’ve probably crossed paths with the annoying legal ditty Past performance is no guarantee of future returns. That’s both irrefutable and obvious, but is nonetheless annoyingly unhelpful.

Extrapolating past performance is what happens in the absence of hard data. And making matters worse is that behavioral economists have determined we’re prone to “recency bias,” which is a fancy-pants academic way to describe the fact that we extrapolate the recent past into the future.
That’s rarely a good idea when it comes to your finances. Case in point: If you’ve been investing for just the past five years, your recency bias might be whispering to you that it’s perfectly normal for stocks to rise 14% a year on average, as they have over that time.
If only. The longer-term norm is 10%, which is actually pretty great, but you had to stick it out during some painful losses to get that return. Or perhaps your formative market event was the tech bubble or the financial crisis, keeping you far, far away from investing in stocks.

Ditch your personal experience and focus your investing assumptions on some longer-term norms.

Reliable annualized data for key U.S. assets stretches all the way back to 1926:

• Big, established U.S. based companies: 10%

• Smaller U.S.-based companies: 12.1%

• U.S. bonds: 5.1%

• Cash: 3.4%

Data for international stocks doesn’t stretch back as far. Over the past 23 years, stocks of companies based in established economies in Europe, Asia, and the Far East have gained an average of 5% a year. Since 2000, emerging markets (think: developing economies such as China and Brazil) have averaged a 9% gain.

In short: Stocks pay off over decades. A 10% return over 30 years will turn $5,000 into nearly $90,000. If you can […]

The Greatest Risk to Your Financial Future

There are a lot of risks to having financial success. One risk is spending too much. Even spending an extra $5,000 per year over your sustainable spend rate can have a significant impact on your long-term financial picture.

Another large risk is taking on more risk than you should in the stock market. This is why it’s important to evaluate your risk capacity and make adjustments when necessary. Another risk is not saving enough toward your goals, like college expenses or retirement. But the greatest risk to your personal financial success is you.

Just as the greatest risk to your health is you ignoring warning signs or not making lifestyle changes when needed, like exercising more or eating more nutritious food, likewise the greatest risk to your financial success is you not doing anything about your financial situation.  It’s so easy to make the following excuses:
1. I don’t have time right now. I’ll do it later. 
If you don’t think you have time now, what makes you think you will find time later?  Waiting until later is a risk that you’re taking and means that you could miss out on years of opportunities.
2. I’ll work on my finances when I’m older. 
Each day you grow older. And taking advantage of opportunities when you’re young gives you a lot more flexibility with your finances when you’re older. It’s extremely rare that an individual gets to retire at age 55 without a lot of prior planning.
3. I’ll plan for retirement when it gets closer. 
If you haven’t started planning for retirement yet, you need to start today!  The earlier you start, the more prepared you will be and the more flexibility you will have.
4. I don’t have enough money to need a financial advisor.
There are financial advisors that work […]

How bull markets affect your intelligence

Lately, it feels like every time I time I log into check my investment accounts the market values are higher than the previous time I looked. The stock market continues to hit all-time high after all-time high. I have to admit, it feels pretty good when things are going your way in the markets and it seems like everything you touch turns to gold.

This is easy. Everything I buy just keeps going up.

It would be nice to assume that my intelligence has risen along with my skills as an investor, but I have to admit that’s not really what’s going on here. We just happen to be in the midst of a strong bull market. So I have to remind myself. Seeing your investments rise is no way to validate your level of intelligence. In fact, it can be extremely dangerous to your wealth when the music stops playing.

Researchers have found that the brain activity of a person who is making money on their investments is indistinguishable from a person who is high on cocaine or morphine. The brain of a cocaine addict who is expecting a fix and people who are expecting to make a profitable financial gamble are virtually the same.

The danger in allowing a bull market to increase your confidence as an investor is that it can lead you to take unnecessary or avoidable mistakes to continue to get that high.

Risk management gets thrown out the window by many during a bull market. You begin to forget how you reacted the last time stocks got crushed. You assume that the good times will last forever, or at the very least, you’ll surely be able to sidestep the next downturn.

Bull markets can force investors […]