5 reasons not to contribute to your 401(k) / One of the most common pieces of retirement advice is to max out your 401(k). Many people — finance gurus included — are convinced this is a surefire way to secure a prosperous life after work.

Cliff Goldstein for MarketWatch writes: The truth is, contributing to a 401(k) isn't for everyone. We'd like to believe in a single universally applicable panacea for retirement planning, but it simply does not exist. Everyone has a unique set of circumstances, needs and goals that will determine the appropriate course of action. In certain situations, dumping money into a 401(k) is imprudent.

Here are five reasons why you wouldn't want to buy into your company's 401(k) plan:

1. You don't have an emergency fund

Everybody needs one. Before saving, spending, investing or pretty much anything that involves moving money around, start by setting up an emergency fund. In the unfortunate case of a job loss, medical emergency or other personal crisis, you'll want to have the assets necessary to carry your family through to safety. Generally, the recommended emergency fund is equivalent to six months of income.

Establishing an emergency fund first is imperative. You don't want to be forced to dip into your 401(k) when hardships arise. Early withdrawal is a costly prospect. You will often be required to pay a 10% penalty fee on top of income tax, plus you're removing assets with tax-advantaged growth potential. There are some narrowly defined exceptions to the penalty, but most people will pay dearly for early access to those funds.

2. Your employer doesn't match contributions

One of the greatest benefits of a 401(k) comes from employer matches on contributions. If you're lucky, your company will agree to match your contributions up to a certain amount. You should almost always meet the company match. It's basically free money. Whether you contribute beyond the match is a decision you'll want to make taking into consideration your other investing options.

Unfortunately, many employers that offer a 401(k) plan don't match contributions. In that case, there are often better investment strategies. Since the money you contribute to your 401(k) will be taxed later in life and often has limited investment options, you may want to opt for an alternative retirement savings account, such as a traditional or Roth IRA.

3. You're swimming in debt

Investing in a 401(k) is a great way to grow your money, but it won't do much good if debt is simultaneously eating away at your accounts. Just as the interest on your savings is compounding to build your assets, so the interest on your debt is compounding to tear them down.

You should generally prioritize paying down current debts before stashing away money for the future. The sooner you pay what is owed, the less you'll lose to interest rates. There may be exceptions to this rule if your company has a generous 401(k) match, so you should probably find a financial advisor to help you in this scenario.

4. You fear future tax increases

Part of the allure of 401(k)s is the ability to defer income tax. You are not taxed on your contributions until you make withdrawals during retirement. However, it doesn't always make sense to defer taxes rather than paying up front.

Currently, the highest federal tax bracket is 39.6%. That may seem high, but historically, it's fairly low. In 1980, the highest bracket was 70%. In 1960, it was 91%. By the time you hit retirement, the country could be back at sky-high levels. Some people may deem it wiser to pay taxes now while rates are reasonable. Of course, predicting the tax brackets of 2030 is as big a gamble as spinning a roulette wheel in Vegas, but it's certainly something to consider.

Along those same lines, deferring taxes until you withdraw in retirement could end up costing you a lot more--even if the tax brackets remain at the same level. If you've invested a lot of money into your 401(k), making large annual withdrawals could potentially place you in a higher tax bracket. This is especially true if you're also drawing significant income from other sources. In this way, the deferment benefit of a 401(k) plan doesn't always work to your advantage. If you make enough for this to be a concern, consider an investment vehicle that allows you to pay your income tax up front.

5. Lack of flexibility and high fees

When you invest money in a 401(k), you shouldn't touch those funds until retirement. Otherwise, you'll disrupt your retirement savings while incurring nasty penalty fees. Putting a lot of money into a 401(k) is a bad idea if you need money immediately or for short-term expenses. When determining whether to squirrel away your earnings for your golden years, consider those funds frozen until retirement.

Be aware, though, that fees associated with 401(k) plans extend beyond early withdrawal. There are also plan administration fees, investment fees, individual service fees, sales charges and management fees. The average household with two working adults will pay $150,000 to $200,000 in 401(k) fees over a lifetime.

You can avoid these fees by choosing retirement savings accounts with more extensive investment choices, or by targeting passive funds in your 401(k) account with lower embedded costs.

Moving 401(k) funds

Karin Price Mueller/The Star-Ledger  writes: Question. Upon retirement, I rolled my pre-tax money from my 401(k) into an IRA. However, there seems to be some controversy about moving after-tax money from a 401(k) into a Roth IRA. My financial adviser says that the IRS has not yet ruled on this and his company advises against it, as they feel that the IRS will eventually rule against it. What is your opinion?

Answer. It’s ugly, but your adviser is probably correct.  "There has been much discussion around this topic and many creative strategies developed to attempt to get around the IRS position," said Diahann Lassus, a certified financial planner and certified public accountant with Lassus Wherley in New Providence. "However, based on recent guidance issued by the IRS in their IRS Notice 2009-68, it pretty much states that you can’t move the after-tax money from a 401(k) to a Roth IRA without tax consequences."

She said distributions from employer retirement plans follow the rules of IRC Section 72(e)(8), which states that taxable distributions will be treated as including a pro-rata share of cost basis or after-tax contributions.

"This means that when you take a distribution from a 401(k), the taxable portion is allocated so that you can’t really separate the pre-tax and the after-tax contributions," she said. "If you transfer the ‘after-tax’ portion of your 401(k) to a Roth IRA and your ‘pre-tax portion’ to a regular IRA, you will end up paying taxes on the Roth conversion for some portion of the Roth IRA dollars."

Lassus offers this example: Assume you have a $100,000 401(k) with $20,000 of after-tax contributions. You roll over the $80,000 to a regular IRA and the $20,000 to a Roth IRA. The rollover IRA would include 80 percent of the basis or $16,000 of the $20,000. She said the Roth IRA would include 20 percent of the basis or $4,000. This means that $20,000 minus $4,000, or $16,000, of the rollover to the Roth will be taxable.

Although there are open questions in this area, Lassus said the IRS position is relatively clear since the issuance of IRS Notice 2009-68. You should also consider that if the IRS did contest the transaction, and the timeframe for being able to recharacterize the IRA from a Roth back to a regular IRA had passed, there could be both tax consequences and potentially penalties and interest for you. The statute of limitations for the IRS to question the transaction is longer than the time horizon to recharacterize a Roth conversion.

Retirement Income: Here’s a New Tool You Might Actually Use / BlackRock just unveiled a new retirement income index that removes the guesswork. Next up: bond funds pegged to the index for near certain guaranteed income.

Dan Kadlec for Time writes: If you have ever played around with an online retirement calculator you probably understand that play is exactly what it is. You end up guessing at inputs, like the inflation rate, your future income tax rate, how long you’ll work and live, and how much you’ll be able to save.

In the end, you either give up or arrive at a highly suspect conclusion. Good calculators are out there, including ones at CNNMoney, AARP, and T. Rowe Price. But most folks don’t have the information they need at hand or the patience they need to find it and complete the task effectively.

A new tool from BlackRock, the world’s largest asset manager, takes aim at these shortcomings and succeeds in key ways: it’s quick and easy, and as accurate in what it attempts to do as any financial planning tool you’ll find. BlackRock unveiled its CoRI tool with a lot of fanfare on Wednesday, using terms like “revolutionary” and “new paradigm.”

Some 45% of workers simply guess at how much they’ll need to accumulate for retirement, according to the Employee Benefit Research Institute 2013 Retirement Confidence survey. “The announcement we’re making today is designed to take the guesswork out of that very important calculation,” said Rob Kapito, president of BlackRock.

In just seconds, an individual within 10 years of retirement can determine how much guaranteed lifetime annual income their nest egg will provide or, alternatively, how much they need to save to reach an income goal. This tool removes one of the biggest planning obstacles to emerge since traditional pensions began to disappear three decades ago and individuals were left to save on their own and later figure out how to make their savings last.

CoRI is an index that represents exactly how much it takes today to guarantee $1 of income when you retire. Plug in your age to get your index level. Then plug in your savings total to find out how much income that will generate at age 65. It’s that simple. Here’s an example:

At age 57 the index is $14.15, which is the dollar amount it takes today to generate $1 of annual income at age 65. This means a 57-year-old with $500,000 will be able to buy $35,336 of guaranteed annual income in eight years. It also means that a 57-year-old who wants, say, $50,000 of annual income at age 65 would need to save $707,500.

The index changes on a daily basis, reflecting a bunch of factors like inflation and interest rates. Today your nest egg might indicate $75,000 of annual income in 10 years but next month it might indicate $72,000 or $78,000. The figure could rise or fall by a third over the course of 10 years. It all depends on the changing economic factors that determine the daily index level.

Individuals may find the volatility off putting. But BlackRock says it is inescapable; the index volatility represents the actual changing nature of how much future income your assets will buy and thus clarifies for all what planners have long known: guaranteed retirement income is a moving target. With the CoRI index you can watch your target and adjust as needed.

The retirement income planning tool is just the start. In coming months BlackRock will roll out a series of bond funds pegged to the index. The idea is that if you buy a CoRI-based fund today you will secure a certain level of income at age 65. You could do that through a deferred annuity too. But BlackRock says its funds will be much less expensive and have the added benefit of keeping your funds liquid to the day you start receiving income.

For Better Or Worse / Experts have only begun to comb the more than one thousand laws touched by the DOMA’s annulment. Regulations, court cases and private letter rulings will further flesh out the implications of the Supreme Court’s decision. It all portends greater opportunity to advise clients about taxes, both the good and the bad.

Eric Reiner for Financial Advisor writes: Massachusetts cpa Erica Nadeau reached out to some of her married gay clients almost immediately after the U.S. Supreme Court declared Section 3 of the Defense of Marriage Act (DOMA) unconstitutional. Among other things, the June 26 decision means married gays in states recognizing same-sex marriage can amend federal income tax returns filed as far back as three years ago and change their filing status from “single” or “head of household” to “married.” For those who filed their ’09 return in the summer or fall of 2010 under an extension, as Nadeau’s clients did, time is running out to get a refund from the change.

“We contacted the clients because we wanted to be proactive,” says Nadeau, a tax principal at DiCicco, Gulman & Company LLP in Woburn, Mass. “Our main concern right now is amending 2009 tax returns for clients who extended their returns.”

From the financial advisor’s chair, the DOMA ruling presents an opportunity to add value to relationships with gay clients and reach out to gay prospects. However, the Supreme Court’s ruling ostensibly affects only gays in states that respect their marriages. The impact elsewhere is debatable, according to Miami-based attorney Diana Zeydel, chair of Greenberg Traurig’s national trusts and estates department.

Taxpayers’ marital status under state law dictates their federal tax status, and the high court was silent about whether the states that don’t sanction gay marriage must recognize unions performed elsewhere. As a result, Zeydel says, “It isn’t clear what the marital status is for federal tax purposes for clients in certain situations.”

Falling in the gray zone are gay couples who wed outside their home state when it does not allow same-sex marriage, as well as those who married and lived in a gay-marriage state but then subsequently relocated to one that isn’t, Zeydel says. The treatment of clients in civil unions and domestic partnerships is murky as well.

Frankly, practitioners also have a lot of questions about filing amended tax returns. Fortunately, the Internal Revenue Service has said it will provide guidance related to the court ruling “in the near future,” without specifying which issues might be addressed first.

Clients who can still amend ’09 income tax returns before the three-year clock runs out should just do it, rather than wait for IRS guidance, says CPA Robert Keebler, co-founder of Keebler & Associates LLP in Green Bay, Wis. But he recommends waiting to amend returns for 2010 and subsequent years until the agency speaks on the subject.

How To Advise
Clients able to take advantage of the court’s ruling need education. In practical terms, the court’s decision in United States v. Windsor immediately switched the federal tax status of gay couples from “single” to “married” in the states where their marriages are honored. Nadeau says advisors should explain to those clients what the federal tax rules are.

If that seems like the script for a dull consultation, remember that joint returns put each spouse on the hook for taxes owed by the other. That will get the clients’ attention. (If that puts an unwanted burden on somebody, then there’s a little comfort in the fact that innocent-spouse relief is now available in same-sex divorces, according to divorce-planning attorney Mary Schmidt, founder of Schmidt & Federico in Boston.)

Another unpleasant discovery such couples will make is that, beginning with 2013 returns, gay couples affected by the DOMA ruling must file their 1040s as married, and some couples will pay more in federal income tax than they did filing singly. Two high earners typically fall in this camp.

For instance, when each partner in a married couple earns $175,000 in taxable income for 2013, they will end up paying over $7,000 more than what the two would pay together if they were single. This figure does not take into account the reduction in itemized deductions and personal exemptions that high-income taxpayers face this year, or the new 0.9% additional Medicare tax on earned income or 3.8% Medicare surtax on investment income.

If they are married, the couple’s $350,000 household earnings would potentially subject them to all of these wrinkles targeting the affluent, depending on the composition of their income and deductions. In contrast, a single person earning $175,000 isn’t subject to any of these things.

Filing federally as married for 2013 may not have been part of the tax plan that gay clients mapped out with their accountant last spring, Nadeau says. “Be sure they are paying enough in estimated taxes or having enough withheld,” she urges.

For single gays in same-sex-marriage states who are contemplating nuptials, “You should crunch the numbers and see what the impact for them would be before they run out and get married,” says attorney Marshal S. Grant at Pierce Atwood in Portsmouth, N.H.

Gift And Estate Tax Implications
Gay couples who are now deemed married under federal tax rules need their estate plans reviewed. “A lot of same-sex couples have plans that don’t quite do what an estate plan for a heterosexual couple could do when it comes to avoiding tax at the first death,” Grant says. “But those objectives are easy to accomplish now that their partner will be a surviving spouse.”

Prior to the ruling, partners were considered unrelated adults.

That had some advantages. Before the Windsor case, “same-sex couples were able to use certain highly leveraged estate-planning techniques the IRS disallows between family members,” Grant says.  “Now they can’t.”

Gift tax returns filed by married gays in the last three years also warrant review, he adds. In the past, gay couples often faced gift-tax consequences for common transactions, say when they purchased property jointly or used funds in a joint financial account that they contributed to unequally. When the amount involved in such transactions exceeded the annual gift-tax exclusion, it consumed a piece of one partner’s $5.25 million lifetime gift-and-estate-tax exemption or triggered gift tax.

“With the change in marital status for federal purposes, the marital deduction for gifts would now apply,” he says. Recasting the transfers as tax-free exchanges between spouses on an amended gift-tax return erases their previous transfer-tax consequence.

Postmortem Planning
Survivors of deceased gay spouses may be able to take advantage of the estate tax marital deduction by amending their spouses’ estate tax returns if these were filed within the last three years. This assumes that the couple was legally married under state law when the first spouse passed away, Grant says.
Cases involving married gays who died after 2010 present another opportunity for amending estate tax returns, according to Keebler, the Green Bay CPA. Because these individuals would have been considered single at death for federal purposes, there was no surviving spouse to benefit from so-called spousal portability, which allows a spouse to pass his or her unused lifetime gift-and-estate tax exemption to the survivor. Today there is, Keebler says.

No conversation about marriage is complete without talk of divorce, even if there is some data suggesting that gay marriages are less likely to dissolve than heterosexual ones. For advisors to gays in same-sex-marriage states, divorce planning is easier now that the federal tax rules apply the same way to homosexuals and heterosexuals alike, says Schmidt, the Boston attorney.

For example, alimony payments to a former spouse in a gay marriage can now be taken as an above-the-line deduction on Form 1040. And property transfers in a same-sex divorce are now “inter-spousal” for federal purposes, rendering them non-taxable, Schmidt says. When prior law treated the partners as unrelated adults, property divisions among divorcing gays were federally taxable.

In situations where gay divorce settlements reflect a tax treatment that no longer applies, some divorced individuals may seek—and conversely, others will have to defend against—a reallocation of marital assets or alimony renegotiation, Schmidt predicts.

Additional planning strategies are bound to emerge in time. Experts have only begun to comb the more than one thousand laws touched by the DOMA’s annulment. Regulations, court cases and private letter rulings will further flesh out the implications of the Supreme Court’s decision. It all portends greater opportunity to advise clients about taxes, both the good and the bad.

The unprofitable SaaS (Software As A Service) business model trap

With the hyper growth of accounting software being acquired as "Software As A Service", (on line via the cloud) we're always interested in where this business model can lead.  Mindful of that we read Jason Cohen, the founder of WP Engine & Smart Bear Software.  He writes for Venture Beat: Marketo filed for IPO with impressive 80 percent year-over-year growth in 2012, with almost $60m in revenue.   Except, they lost $35m. WTF?

Don’t tell me this is normal for growing enterprise SaaS companies.It’s not impressive when you spend $1.60 for every $1.00 of revenue, force-feeding sales pipelines with an unprofitable product.

I know the argument: The pay-back period on sales, marketing, and up-start costs is long, but there’s a profitable result at the end of the tunnel.  Just wait!

Bullshit. Eloqua was also a SaaS company, also selling to enterprise, selling the same product in exactly the same space, also tightly integrated with Salesforce.com, and IPO’ed with a $5m loss on $71m in revenue — a 7 percent loss instead of Marketo’s massive 60 percent loss.

So no, this upside-down business model isn’t what a SaaS business should construct.  I wish the modern startup community would understand the mindset that gets a company to this point, and resist it. 

The mindset works like this:

1. It costs a lot of money to land an enterprise customer.  Marketing, sales, legal, account management, on-boarding, technical guidance, training.  And: how many times do you run through that process and still lose the customer?  So these costs are amortized over the customers you do land.
2. 
   
3. SaaS companies earn their revenue over time.  Whereas a normal software company might charge $100,000 for an Enterprise deal, and thus immediately earn back those “customer startup” costs plus profit, the same SaaS deal might be $5000/mo, and it might take 18 months to get that same amount of revenue.  The good news is, after that 18 months, the SaaS company still charges $5000/mo.  The other company has to bust ass for measly 20 percent/year maintenance fees.
4. 
   
5. As a result, enterprise-facing SaaS companies are unprofitable for the first 12-24 months of a given customer’s life.
6. 
   
7. But, a growing SaaS company will be landing new customers, and in increasing numbers, which means piling up more and more unprofitable operations.
8. So much so, that even when an older customer individually crosses into profitability, there are so many more unprofitable customers, the company remains permanently unprofitable so long as it maintains healthy growth.
9. 
   
10. Plus, there’s all the other costs — R&D to build the stuff, office space, executive salaries, billing, legal, finance, HR, tech support, account managers. To actually be profitable, you need to cover those costs too. So it takes even longer to be bottom-line-profitable.
11. Therefore, it is healthy and reasonable for SaaS companies to be unprofitable as long as they’re growing even a little bit.

Early in a company’s life, this line of reasoning is correct.  But at Marketo’s size, this argument falls apart.

Why, exactly?

There’s a tacit assumption that if only we just stopped spending to grow, we’d be profitable.  Thus, this “really is” a profitable company, and the only reason it’s not is growth, which means market domination, which is a Good Thing.

The fallacy is: That time never comes.  No company stops trying to grow!  The mythical time when growth rates are small so the company reaps the rewards of having a huge stable of profitable customers never arrives.  When do you “show me the money?”

It’s worse. Growth becomes harder and harder for SaaS companies because of cancellations.  Even with a great retention rate (e.g. 75 percent/year), you have to replace 25 percent of your revenue with new — which means unprofitable – customers just to break even in top-line revenue!  More losses, more unprofitability.

Even with very broad numbers, you can see how this model doesn’t work.  Here’s typical numbers for an enterprise SaaS company at scale:

• 1.5 year pay-back period. (i.e. time to earn back the revenue to cover all your customer acquisition expenses)
• 75% annual retention.  (Which also means you turn over the entire customer base every 4 years.  On average of course — some stay longer, many shorter.)
• 30% cost to serve the customer.  (Can also be stated at 70% Gross Profit Margin, meaning for every $1.00 of revenue, $0.30 disappears in direct costs to service that customer, like servers, licenses, tech support, and account management.  Many public SaaS companies, even the titans like Salesforce.com, are about 70% GPM.)
• 15% revenue == cost for R&D department.
• 15% revenue == cost for Admin department. (office space, finance, HR, execs)

Say the average customer represents R dollars in annual revenue.  That’s:

• $4R of revenue over the lifetime of the customer.  But:
• $1.5R is spent to acquire the customer (the pay-back period).
• $1.2R is spent in gross margin to service the customer (4 years times 30% cost).
• $0.6R spent on R&D (15% over 4 years).
• $0.6R spent on Admin (15% over 4 years).

So out of the original $4R, we’re left with $0.1R in profit.  That’s 1/40th of the revenue making its way to actual bottom-line profitability, and even that takes 4 years to achieve.

And that is without any growth at all.  But you need to grow enough to keep up with cancellations at minimum, so that consumes the last notion of profitability.

What’s the solution?

Successful, profitable SaaS companies at scale (certainly by $30m/yr revenue, but should to be paying attention to this stuff by $5m/yr), do several things to make the math work:

1. Undo the effect of cancellations through up-sells/upgrades
   Salesforce.com and ZenDesk charge more for every person you add, and more per person when you increase the features in your plan.  Their customers grow (on average).  Thus, their revenue over four years is not 4R, but rather it might be R on the first year, 1.5R on the second, 2R on the third, etc., so perhaps 7R in four years.  That drastically changes the equation, because cost to “acquire” the customer doesn’t go up, and in general R&D and Admin don’t either. Taking “rate of cancellations” minus “rate of upgrades” is called “net churn.”  Getting to zero net-churn is a big step in getting profitable; the most successful SaaS companies have negative net churn.  It’s not just pure software companies that achieve this — hardware/server SaaS company Rackspace also has negative net churn, which enables them to grow revenues 30% year-over-year with $1.5 billion in revenue and $300m in profit.
2. 
   
3. Use viral growth to offset cancellationsFew B2B companies can truly claim “viral growth” characteristics.  But for the few who do, they can maintain growth rates of X%/yr where X is much larger than cancellation, and do so with very little acquisition costs.  In this case, cancellation never “catches up,” and you win
4. .
5. Drastically reduce the cost of customer acquisitionAn 18-month pay-back period is a killer.  If customers can be found with paid advertising, if they can sign up without talking to a sales person, if they can learn the product through in-product tutorials, great documentation, and how-to videos, if they can import their data without assistance, if they can demonstrate value to the purse-string-holders without a sales person writing the presentation for them, then the cost of cancellation-replacement and proper growth becomes small enough that it’s no longer a barrier to profitability, even under conditions of growth.
6. 
   
7. Drastically improve GPMIt’s hard for a service-oriented enterprise-sales company to not have real costs around tech support, account management, and extensive IT infrastructure, which is why even the most cost-efficient (and profitable!) enterprise-facing SaaS companies often can’t push much past 70 percent GPM (e.g. Salesforce.com, Rackspace).  But, companies with extremely low-touch customer service (which doesn’t necessarily meanbad customer service!) can push it way up (Google, Facebook, Freshbooks), unlocking “free money” for profitability.
8. 
   

Another way to think about these solutions is that a SaaS business cannot have static fundamental metrics.  The metrics themselves need to improve — lowering cancellation rates, lowering net churn, increasing GPM, reducing cost to acquire customers.  Leaving the metrics alone, and trying to “grow until profitable” doesn’t work.

It’s like the old Jackie Mason joke — A man is selling jackets at cost.  The customer asks “how can you sell at cost, how do you make any money?”  Answer: “I sell a lot of jackets!”

Marketo is selling a lot of jackets.