Friday, October 19, 2012

I Got a New Job -- 401(k) or Roth IRA?

This week Farnoosh answers your questions about deciding between a 401(k) and a Roth IRA, paying one credit-card bill with another credit card and "hard inquiries."

Dariela asks: I have a question regarding my 401(k) that I will be starting in a month at my work. I am 24 years old, no kids, not married. What is a good percentage to put towards it, or should I get a Roth IRA instead?

Happy – and so impressed -- to know you’re starting to plant seeds for retirement at your age.

My advice is, first and foremost, take full advantage of your company’s 401(k) matching policy. If your employer contributes 50 cents for every $1 you contribute, up to, say, 6% of your salary, then contribute at least 6%. Why leave free money on the table?

While 6% is a decent start (and, really, it’s 9% with the match) – it isn’t great. “It may not be enough to get you to the level of savings you need to help assure a comfortable retirement,” says Nevin Adams, co-director of the Employee Benefit Research Institute’s Center for Research on Retirement Income.  Ultimately, a 10% to 15% distribution each year towards retirement savings is ideal. You won’t know for sure until you run the numbers and project what you anticipate needing in retirement – based on your goals, when you plan to retire and future anticipated expenses -- with the help of online calculators at and the AARP website. From there, you can determine how much you should try to be saving annually to meet that precious figure, which, by the way, isn’t a hard and fast figure and may change over time. 

As for where to put that additional savings, the choice between a 401(k) and a Roth IRA depends on your personal tax situation now and in the future. Unlike a 401(k), which allows you to defer paying taxes until you begin making withdrawals, the benefit of a Roth IRA is that you pay taxes today at your current rate, which is likely to be lower than, say, 40 years from now when you’re nearing retirement. Many financial experts are championing the benefits tax diversification in long-term savings – especially for younger workers, who are more likely be paying a lower tax rate now than they will later, says Adams.  In short, if you think you’ll pay higher taxes in retirement, you may want to put some of that savings in a Roth and minimize Uncle Sam’s bite.
From Facebook: It's time to start borrowing from Peter to pay Paul. Can I make a credit-card payment with one card to pay for another, and are there typically additional charges for doing so? 

What you can do is transfer the balance from one card to another to take advantage of another card’s more favorable terms. You may be tempted to do so if you’re strapped for cash and you find a card with a lower interest rate or 0% introductory rate offer. But to warn you, there are usually hefty fees associated with doing so, typically 2% to 5% of the transferred balance.  So if you’re transferring $1,000, that’s up to $50 in fees. “These fees can impact or even potentially offset the savings in interest charges depending on the amount of the transfer, length of the promotional rate on the new card and the interest rate differential between the old and new card,” says Ben Woolsey

In my experience helping families and individuals with credit-card debt, transferring a balance often becomes a way to just manage the debt, rather than erase the debt. As Gerri Detweiler of Credit.comsays, “Don’t just take care of the payment. Take care of the debt.”  If you really want to nip it in the bud, consider working with a credit counseling agency, such as The National Foundation for Credit Counseling or Money Management International, that can help you establish an effective repayment plan. 

Richard asks: I started using credit cards four years ago. Recently I requested to increase my credit limit for my oldest credit card. When that happened, I received an email about a hard inquiry. I've never received a hard inquiry before and doing a little research on my own, found out it is bad. Why is this bad and how do I turn this bad to good?

When applying for new credit, either a loan or credit card, the lender will typically request to access your credit history. The act of doing so is called a “hard inquiry” and it’s often looked down upon as far as your credit score’s concerned. Why? The perception is that when you’re applying for new credit – even if it’s just an extension of existing credit – it signals that you may be in a financial bind or could have trouble paying your bills. I know – it doesn’t exactly give you the benefit of the debt. But if it does end up dinging your score, it won’t cost more than five points. Multiple hard inquiries in a short time frame – say, when you’re applying for various store cards at the mall one weekend – could do more damage.  Hard inquiries stay on your credit report for no more than 24 months, and after the first year don’t impact your score. 

And while we’re on the topic, the other type of credit inquiry is a “soft inquiry,” associated more with periodic checks, like when you or your bank reviews your credit report. Soft inquires don't affect your score. 

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