Three Lessons in Work and Life

Business icon Jack Welch once told Reader’s Digest what he’d learned from three jobs he had growing up: caddying, punching holes in a piece of cork, and selling shoes.

• Caddying. The future CEO of General Electric loved being out on the golf course hearing all about the big deals being made by the businessmen and the affluent. “It was like being a fly on the wall at a meeting.”

• Cork. Punching holes into a sheet of cork for a Parker Brothers game called “Dig” was his first glimpse into monotony. “It lasted about a month,” he says, “and I concluded that I never wanted to do anything like that again—ever.”

• Shoes. It was through his third job, selling shoes, that he learned the basic tenet of business: Close the deal. “If they didn’t like a shoe,” he says, “I always tried to be thinking ahead to a pair they might like better.” Every time someone walked into the store, he said, he felt he was stepping up to the plate to swing for a home run.

“Today I believe that the worst sin in running a big company is to manage its size rather than using that size,” he says. “The advantage of size is the resources it gives you to go to bat often. You have to take risks in business. If you take a risk and fail, get up to bat and swing again.”

Always Question the Premise

After World War II, Gen. Dwight D. Eisenhower served for a time as president of Columbia University. According to one story, a committee of faculty members once asked him to issue a rule prohibiting students from walking on the grass in the main quadrangle.

Before issuing a statement, he asked, “Why do they walk on the grass?”

“Because it’s the shortest way to the central hall from the main entrance,” the committee answered.

“If that’s the way they are going to go,” he said, “then cut a pathway there.”

Eisenhower understood that telling people what not to do isn’t always the best course of action.

Borrowing from Your 401(k)

With the current economy, people are borrowing from their 401(k) plans at record levels.  When times are tough that particular pool of money begins to look very attractive.  But, deciding to access that pool might not be as easy or straight-forward as you think.

While every 401(k) plan is different, most will let you borrow as much as 50% of your vested balance up to $50,000.  The loan is paid back through your paycheck, with interest.  Most plans have competitive interest rates and the loans can be carried for up to 5 years.  If you use the proceeds of the loan to purchase a primary residence, that pay-off term may be extended.

When you are making payments back into the loan, you are paying yourself interest on the money you borrowed.  This is where it gets a bit foggy.  First, when you draw your paycheck, you pay taxes on the earnings.  Then you pay the interest on the loan out of what remains.  At a later date, say retirement, you begin drawing from the plan.  Those distributions are taxable income, therefore taxed again.  You are paying income taxes twice on the funds you use to pay interest on the loans.  (Special tax rules apply to Roth 401(k) contributions).

There is an opportunity cost with taking a loan from your 401(k) as well.  If those funds are not invested, they are not continuing to grow tax deferred.  So, what is the opportunity cost?  Well, you need to compare the interest you are paying yourself and the future tax implications previously discussed with the lost opportunities of tax deferred investment returns.

There are other considerations as well.  For instance, if there is a separation from employment, the plan may require that the loan be immediately repaid.  If you don’t have the funds to repay the loan, it is treated as a taxable distribution.  If you are not age 59 ½ or more, a 10% early withdrawal penalty may also apply to the taxable balance.

Whether or not you can afford to pay back the loan and still make contributions to the plan should be carefully considered.  Would the circumstances that have lead you to look at borrowing the funds as an option impair your ability to repay the loan?  If so, this might not be considered a viable option.

The interest you pay on alternative financing options may be tax deductible.  For example, the interest on a home mortgage often qualifies for a tax deduction.  However, the interest on a plan loan repayment often is not.  Be sure to weigh the comparisons of tax deductibility for both alternatives before making a decision.

Every plan is different and will have various restrictions.  Consult with your plan administrator before deciding to borrow from your 401(k).

Taxes and Social Security

   If you are looking forward to retirement and tax-free Social Security income, you might be surprised when the IRS comes around for a bite. Yes, way back when Social Security was a young program, President Franklin D. Roosevelt promised no income taxes would be exacted, but that promise ran out in the 1980s for some people whose income exceeds certain levels.

Now the federal government considers the retirement entitlement as taxable income when your other income plus half of your Social Security exceed an amount based on your filing status ($32,000 if you filed jointly, $25,000 for single filers). First, only 50 percent of your benefit above a certain threshold is taxable. When you exceed the first threshold, up to a maximum of 85 percent of your benefit can be taxed.

You can continue to work and still receive retirement benefits. Your earnings in (or after) the month you reach your full retirement age will not reduce your Social Security benefits. But your benefits will be reduced if your earnings exceed certain limits for the months before you reach your full retirement age.

If you work for someone else, only your wages count toward Social Security’s earnings limits. If you are self-employed, the federal government counts only your net earnings from self-employment.

Income from other sources is not counted, such as other government benefits, investment earnings, interest, pensions, annuities and capital gains.

If you work for wages, income counts when it is earned, not when it is paid. If you have income that you earned in one year but the payment was made in the following year, it should not be counted as earnings for the year in which you received it. Some examples are accumulated sick or vacation pay and bonuses.

If you are self-employed, income counts when you receive it—not when you earn it—unless it is paid in a year after you become entitled to Social Security and earned before you became entitled.