401(k) Plans As Your Personal Piggy Bank

Tax and Financial News for July 2016

401(k) Plans As Your Personal Piggy Bank

Short-sighted. Impulsive. Terrible idea. Robbing your own retirement. These are just some of the things you will hear in the financial media when it comes to borrowing money from your 401(k) plan. How much of this is reality and how much is myth? We are going to explore how 401(k) loans really work and when they could be a good idea – or the worst plan ever.

How 401(k) Loans Work

Unlike traditional loans, borrowing from your 401(k) is not a true loan in the sense that there is no lender involved and your credit score is not a consideration. More accurately, they represent the ability to access part of your own retirement plan money, which must then be repaid to restore your 401(k) plan to approximately its original state.

You pay the interest on the balance of a 401(k) loan is back into the account. As a result, the impact on your retirement savings can be minimal – and in many cases it will be less than the cost of paying interest on a bank or consumer loan.


  • Quick & Easy: Typically, requesting a loan inside most plans is simple. Most plans do not require long applications or credit checks, which means there is no credit inquiry impacting your credit score. A growing number also allow participants to make their request online.
  • Flexible Repayment Options: The majority of plans allow accelerated repayment or prepayment with no penalty. Often you can set up the repayment to happen directly through your company’s payroll withholding.
  • Low Fees: While there can be loan origination costs or maintenance fees, these fees are relatively nominal compared to most conventional lending sources, which can come with big application fees or origination fees.
  • Help (or at Least Don’t Hinder) Your Retirement: Payments are usually allocated back to the investments you borrowed from or chose to apply them to. This means the interest you are paying yourself will be added to your investments. There is no definitive loss of investment earnings either. If the investments would have increased in value, then yes, you miss out on those investment gains; but the flip side is also true. If the market goes down, then you miss out on any losses as well. Most of the strongest critics of 401(k) loans tend to assume that the market only goes up when they make their arguments, and we all know this isn’t true.
  • Pay Yourself Not the Bank: Yes, you are paying interest on the loan; however, you are paying yourself the interest. Interest paid on consumer debt such as credit cards comes at much higher interest rates and goes in someone else’s pocket.


401(k) loans are not all peaches and cream. There are some serious disadvantages, including:

  • If you are terminated or quit, you have to pay back the full loan in a lump sum or it is a deemed distribution. This means you’ll have to pay taxes and likely a 10 percent penalty on the remaining loan balance. This can be negated by qualifying for a hardship withdrawal or paying the loan back within the grace period, typically 60 to 90 days.
  • If you are borrowing the money because you are in financial trouble, you need to make sure you budget for a lower future paycheck as it is paid back.
  • If the investments you borrowed against do produce stellar returns, you will have forever missed out on those gains and the potential compounding.


401(k) loans are not always a bad idea. Under the right circumstances, they can provide a simple, convenient and lowest-cost borrowing option. Yes, they have potential disadvantages, but so do all loans if they are taken irresponsibly or at inopportune times.



Financial Planning for July 2016

How Morningstar Rates Mutual Funds

Mutual funds started to become popular back in the 1980s. However, there was one problem. Lack of information. While stock investors could get information on individual companies, mutual funds were comprised of up to hundreds of companies in different allocations, so individual holding research was futile.

Then along came Morningstar founder Joe Mansueto, who formed the company in order to provide readily available information about mutual fund performance, along with analysis and commentary. Established in 1984, Morningstar is now well-reputed as an independent investment research firm that offers assessments for all types of investments, including stocks, mutual funds and exchange traded funds.

Morningstar’s publication, The Mutual Fund Sourcebook, is a quarterly guide that provides performance data, portfolio holdings and other information on the majority of mutual funds currently available. The company also boasts Morningstar data and proprietary analytical tools, including the Morningstar Rating system for investments and the Morningstar Style Box that depicts each fund’s overarching investment style.

Morningstar is probably best known for its mutual fund ratings, ranging from one to five stars. These ratings gauge the performance of each mutual fund within the context of its risk profile as compared to similar funds. Ratings also adjust for the individual sales charges for each fund. The ratings system covers more than 100 different fund categories by different share classes, which are subject to various fee structures and therefore yield total return deviations.

Within each mutual fund category, Morningstar assigns five stars to the top 10 percent of funds and only one star to the bottom 10 percent. Funds with at least three years of performance are rated by separate time periods (three, five and 10 years); the company doesn’t rate funds with less than a three-year history.

The following factors are combined to create an overall rating for each mutual fund:

  • If a fund is three to five years old, its overall star rating will be the three-year rating;
  • If a fund is five to 10 years old, its overall rating will be 60 percent of the five-year rating and 40 percent of the three-year rating;
  • If a fund is more than 10 years old, its overall rating will be 50 percent of the 10-year rating, 30 percent of the five-year rating and 20 percent of the three-year rating.

The Morningstar Style Box is a visual graphic consisting of a nine-square grid. The Style Box for equity funds features a horizontal axis depicting value, growth and blend investment management styles, which is cross-sectioned against a vertical axis for large-, mid- or small-cap equities. To demonstrate a mutual fund’s style, for example, a filled-in box that meets at growth and large-cap would indicate that the majority of the fund’s holdings are large-cap and the fund manager uses a growth style of investment management.

The Fixed-Income Style Box depicts a horizontal axis for duration (short/limited, intermediate/moderate, long-term/extensive), which is an indicator of a fund’s interest rate sensitivity. The vertical axis depicts a fund’s credit quality as either low, medium or high.

The Morningstar Rating system for investments and the Morningstar Style Box combine to provide both investors and money managers a convenient way to evaluate mutual funds, particularly in comparison with similar types of investment options.



Tip of the Month for July 2016

IRS Aims to Boost Small Business Tax Compliance

The Internal Revenue Service believes the small business sector is a major source of under-reported income.For the past four years, the agency has run a special independent office charged with finding how to encourage small business owners to report their earnings more accurately. The IRS finds sole proprietors especially challenging. Many operate on a cash basis – at least in part – and report income on their personal tax returns, making it difficult for the taxman to correctly identify the sources of their cash flow.

The research that has been conducted to date has brought forth some interesting statistics:

  • Estimates suggest that as much as 60 percent of small business revenue isn’t tracked on tax information documents submitted by third parties, though this is likely to change as technology advances;
  • Studies suggest that tax scofflaws are more likely to be found in certain areas of the United States such as California, Georgia, Texas and other Southern states;
  • Reports suggested that intentional under-reporting was less of a problem than under-reporting due to confusion about the tax code and/or poor record keeping;
  • Business owners who are caught by the IRS often become more compliant – but only for a few years – with many back-sliding into the bad habits that triggered an audit in the first place.

Small business owners would be well advised to pay attention to the IRS’ focus on entrepreneurs. The majority of audit candidates are not picked by random selection. The IRS makes use of an algorithm to try to identify taxpayers most likely to have unreported income. This algorithm appears to be a very effective way to sniff out tax offenders. Once a taxpayer is flagged, almost 90 percent ultimately prove to owe more money than they reported. However, the agency’s budget cuts have hit home, and it must be noted that only approximately 1.5 percent of self-employed taxpayers are audited each year.

Whether intentional or not, the IRS estimates unpaid tax revenue at more than $450 billion a year. Although audits are used more than any other tool to catch business owners who under-report their income, the discovery process is burdensome to the IRS. The amount of time, staff and money needed to conduct them makes audits a costly method of collecting taxes from scofflaws. It is seen as an increasingly inefficient way to close the tax gap.

This doesn’t mean that audits are going away, but it does mean that the IRS is actively trying to find new ways to encourage business owners to report earnings more accurately. Tax experts urge their small business clients to recognize that increasingly complicated reporting requirements make it crucial for entrepreneurs to seek professional tax help. The interconnectivity of technology in the finance and banking world means more transparency and less privacy for taxpayers. The odds might be slim, but business owners should be prepared for the possibility of an audit and be scrupulous in their documentation. Without a paper trail, even the most honest business owners are subject to a time-consuming and worrisome review. It’s simply not worth the risk.