by Nilus Mattive 08-24-10

Fidelity just released a new report and it’s pretty depressing.

The upshot? A record number of Americans are making hardship withdrawals from their 401(k) retirement plans. Worse yet, the number of U.S. workers borrowing from their plans is also at a 10-year high!

I’ll get to why this is so disheartening in a moment. But first …

A Quick Look at the Ways to Remove Money from a 401(k) Plan

The 401(k) plan is the most ubiquitous retirement account in the United States, and for good reason: Any money employees contribute is not counted for income tax purposes. Instead, it’s taxed — along with investment earnings — upon withdrawal.

So how and when can money come out of a 401(k) plan?

The first way is upon retirement, which is defined by the tax code as the contributor reaching age 59 ½. At that point and beyond, any money that comes out of a 401(k) plan is simply taxed as regular income.

The second way is through separation of employment. In this case, the contributor has four choices, which boil down to:

1. Leaving the money where it is
2. Rolling it over into a new employer’s plan
3. Rolling it into an Individual Retirement Account
4. Withdrawing it.

When done correctly, the first three options don’t result in any taxes or penalties. However, the fourth option DOES (unless the employee also happens to meet the conditions for retirement discussed above).

In short, money that comes out of a 401(k) plan before the contributor reaches age 59 ½ results in both regular income taxes being due but ALSO a 10 percent early withdrawal penalty.

The third way is through what is known as a “hardship withdrawal.” While they’re not required to do so, most 401(k) plans allow contributors to remove money under certain circumstances — including medical expenses, the purchase of a principal residence, tuition and related educational costs, and funeral expenses.

Individual plans have some leeway in how they specifically define “hardship” and what particular events can trigger withdrawals, but the IRS does provide the following guidelines:

“For a distribution from a 401(k) plan to be on account of hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent.

“Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee’s non-spouse, non-dependent beneficiary.

“A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children. Whether other resources are available is determined based on facts and circumstances.”

In a few specific cases — such as death, permanent disability, or termination of service after age 55 — the IRS will not impose the 10 percent early penalty on these withdrawals. But in most other cases it will.

Worse, employees will also be required to pay ordinary income taxes on the amount removed.

And they will most likely be barred from contributing any new money to any employer retirement plan for at least the following six months!

The fourth way to remove money — temporarily — from a 401(k) is through a loan. Many plans will also allow participants to take out loans from their 401(k) accounts.

Generally, these loans have five-year terms — unless it’s for a primary residence — and carry fixed interest rates. Repayments must be made in regular installments, and everything goes back into the 401(k).

Now, Here’s Why I Find All the Current Borrowing and Withdrawing So Troubling …

Obviously, a lot of Americans have hit rough patches lately … and other sources of credit remain in short demand … which is why hardship withdrawals are at an all-time high.

Borrowing from a retirement account now could leave you struggling down the line …

But with so many people nearing retirement already grossly underfunded, watching even more money flow out of their accounts is going to prove catastrophic down the line.

And since most of those withdrawals are getting hit with not just regular taxes but also the additional 10 percent penalty, we’re talking about a lot of nest egg money getting vaporized before it even goes toward their immediate needs!

Oh, and get this — Fidelity said 45 percent of the people who took a hardship loan last year took ANOTHER ONE this year!

What about all the 401(k) borrowing going on?

Well, on the surface it’s better to take a loan than an outright withdrawal because taxes and penalties aren’t assessed.

Still, there are a couple of things I find problematic:

#1. Unlike hardship withdrawals, there are no hard-and-fast rules on loans. So there’s no guarantee that this money is truly being borrowed for dire circumstances. People could simply be tapping their future retirements in the same way that they tapped their home equity a few years ago.

#2. While it’s true that this money should ultimately be repaid, and at least the interest will go back to into the retirement account, it essentially means that very little new money will be contributed. The end result will be a lower final balance and the loss of the very tax advantages that make 401(k)s attractive in the first place.

Look, if you’re absolutely stuck right now, then you’ve got to do what’s necessary. But in my opinion, you should avoid 401(k) hardship withdrawals at all costs … and think long and hard before you consider borrowing against your future retirement.

After all, the other typical sources of retirement income are looking shakier than they ever have before … and the folks tapping their 401(k)s may find themselves completely out of options in their golden years.

Best wishes,

Nilus

© 2010 by Weiss Research, Inc. All rights reserved.

Here is a very interesting guest article by Nilus Mattive, the Dividend expert at Money and Markets.

Answers to Three Important Dividend Questions

by Nilus Mattive   08-17-10

I get asked a lot of great questions — both on my blog and through e-mails — and today I want to answer three very important ones that all relate to dividend investing.

Let’s start with a major source of concern for many Americans right now …

“What Will Happen to My Dividend Stocks If Congress Lets the Current Tax Cuts Expire?”

Pretty much every newspaper in the country has been running stories about the Bush tax cuts and whether or not Congress will let them expire at the end of this year.

However, most reporters and pundits have chosen to focus on tax brackets, and whether higher-income Americans should be forced to pay bigger tabs. I hear very little talk of how one aspect of those cuts will affect many U.S. investors — particularly retirees — regardless of their overall income picture.

First, a quick recap: As part of President George W. Bush’s Jobs and Growth Tax Relief Reconciliation Act of 2003, which was signed into law on May 28 of that year, tax rates on both capital gains and qualified dividends were reduced to rates of 5 percent for the lowest income brackets and 15 percent for everyone else. Originally set to expire at the end of 2008, these cuts were extended through the end of 2010 with legislation passed in 2006.

Now, the question is whether or not these changes will sunset come January 1. While I can’t say what Washington will ultimately do, there are a few points I’d like to make:

First, it’s entirely possible that lawmakers will recognize the importance of dividend income to millions of older Americans, especially in this pitiful interest rate environment, and choose to extend that particular feature even if they let other aspects of the legislation expire. At the very least, I hope this is the case.

Second, even if tax rates do go up on dividends, I don’t expect a major effect on the share prices of dividend stocks. In other words, investors are not going to run for the hills or anything.

Consider the alternatives and you’ll see why: CDs and money market funds are still paying nothing … and it’s certainly better to give back more of your income than to have no income at all!

Besides, nearly any other form of investment income would be subject to the same rates going forward anyway.

A Roth IRA is one great way to shield dividend income from any future tax hike.

Third, if you’re holding dividend stocks in tax-sheltered accounts like IRAs, this is really a moot issue anyway. And even if you’re not currently holding your dividend stocks in such an account, you can probably find a way to either shift them into one now or at least make future purchases under such an umbrella going forward. A Roth IRA would be the ideal choice.

In short, I sincerely hope the lower rates stay in effect — because a change will impact plenty of Main Street investors and retirees, not merely the ultra-rich. However, even if the tax cut expires in 2011, the effect on share prices should be small and the alternatives for minimizing the impact many.

Which leads me to another question I get asked …

“Where Are You Finding the Safest, Richest Dividends Now?”

Three weeks ago, I gave a pretty detailed breakdown of recent dividend trends. If you missed it or want to re-read it, just click here.

But here’s the basic answer: If we’re talking sheer numbers of above-average yields and the highest likelihood for continued dividend increases, I continue to believe the best sectors are consumer staples and utilities. As a bonus, both groups are less economically sensitive, too. However, I have been finding good potential opportunities in nearly every corner of the market — telecom, energy, even technology.

The key right now is paying a fair price. A lot of stocks that I would love to recommend just look a bit expensive at the moment. So I’m keeping them on my watchlist and waiting for pullbacks.

And when I am issuing new buy orders, I’m providing limit orders as insurance against overpaying and getting caught in a “bear trap,” a market rally that ultimately fades.

What about really high yields — ones that exceed 7 percent, 9 percent or even reach double-digits? There are a couple relatively conservative companies I like that are touching those levels at the moment — such as the foreign utility I mentioned last week. But if I had to name one sector that had the largest selection of really big yields right now with some degree of dividend safety, I would point to telecom companies.

And all this talk about sectors leads to one last important question …

“How Important Is Diversification Now?”

After the market action over the last few years, a lot of investors have completely given up on the concept of owning a number of different investments.

But I think they’re wrong. Diversification does still provide additional downside protection and allows your portfolio to continue profiting from different trends as they come and go. Heck, if you have just three dividend stocks as your sole sources of investment income and one of them unexpectedly cuts their payment, you’ll be in a pretty bad spot!

This is why I never make new investment recommendations in a vacuum — instead, I always look at how each position relates to other existing holdings, both in terms of purpose and size.

If you’re building your own portfolio, the same basic idea holds true: Try to hold companies that operate in a number of different sectors and industries … pick some smaller firms and some larger ones … and consider some foreign investments, too.

And even though there’s a lot to love about dividend stocks right now, always mix in some bonds and other types of investments, too.

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About Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

My previous post about the cash for gold scams got tons of comments and was one of the most read post ever, so I though I would do an update. (If you missed that post you may want to read it before you read this. Be sure and read some of the comments)

Where is the best place to sell my gold?

I have been both a buyer and seller of gold for the past few years.  I started buying gold just after 9/11 when gold was down around $350 an ounce.  Today Gold is hovering around $1200.  This increase is what has brought people out of the woodwork who want to sell their gold.

Some of you have gold coins but most people have gold jewelry or other things made of gold lying around and they just want to cash in on them.  Other’s need to sell their gold due to the economy and just need to raise funds.  So where is the best place to sell your gold.

The place not to sell your gold is the online gold firms who advertise on the web and on radio and TV.  I won’t mention any specific firms, as they like to sue people to keep their names off of blog posts like this one.  Even though I have liability insurance to protect me against those types of suits, I don’t want my rates raised if I get too many claims.

It turns out that the best place to sell your gold is your local gold dealer or coin store.  Scrap gold sells for between 15% and 60% of its spot gold value.  The large online firms that advertise on radio and TV will most likely give you something near the lower end (15% to 20%) but a few of the more famous ones have been known to give people even less than 10%.  But when I took my scrap gold to two local coin shops with signs in their window that said We Buy Gold and Silver, I got an offer of 35% from one and 44% from the other one (a rare coin shop in Bellingham, WA).  As an aside, these stores were also selling gold bullion and coins for a lower markup than the large gold companies that advertise on radio and TV.

The first thing to do is determine how much gold you have.

First look at the karat rating.  Gold’s purity is measured in karats. The term “karat” goes way back to the ancient bazaars where “carob” beans were used to weigh precious metals. 24 karat is pure gold.  Different alloys are used in jewelry for greater strength, durability and color range.  A piece of jewelry’s karat rating will tell you what percentage of gold it contains: 24 karat is 100 percent, 18 karat is 75 percent, and 14 karat is 58 percent gold. When comparing gold jewelry, the higher the number of karats, the greater the value.

Here is a chart that shows the relationship of gold’s karats to its purity by weight:

Gold Karat Chart

Step one is to weigh your gold and apply the karat percentage rating to determine what you have.  Here is an example:

You have a gold wedding ring that weighs .4 ounces and is 18K gold.  So the math would be 0.4 x .75 = .3 ounces of gold.  Now check the spot price of gold.  (You can find the spot price of gold on any given day at http://www.goldprice.org). When I checked the price today it was $1196.  So now multiply .3 X $1196 and you get $358.80.

That is how much your gold ring is worth if it were in bullion or coin form, but its not.  When someone buys your gold they have to melt it down and remove the impurities. Then they have to forge it into ingots and test and certify it for purity.  This is an expensive process, which is why dealers only pay you a percentage of the spot price.

Remember earlier where I said not to sell your gold to the large cash for gold firms: One of my readers did some research and found that the four largest cash for gold firms were paying less than 20% whereas his local pawn shop was paying 40%. So once you check your local coin shops, also check your local pawnshops.

Melt Your Own Gold

There is another way to get a slightly higher price and that is to do some of the work yourself.  If you melt the gold and form it into some sort of wafer or ingot, gold dealers will usually pay you a much higher percentage.  In fact if you learn to do this you could become a gold dealer as a hobby. You would buy gold from your neighbors and friends and melt it down and sell it at a higher price.

Here is a link to an article that shows you how to melt gold for resale. One thing you will need is a melting crucible and a torch.  A good company for gold melting supplies is QTE north America.  Professional gold melting supplies can run up to $1000 or more, but at the hobby level you can get started for less than $100 with a simple crucible and torch.

1 KG Gold Melting Graphite Crucible (cost $16.95)

With a crucible like this and a good torch set, you can melt up to one kilogram of gold at one time.  You will also need filter paper to remove the impurities.