Retirement Planning

401(k) Not Ok?

July 4, 2007

No time to read a half-dozen articles about retirement plans before the fireworks tonight? Well today is your lucky day. MAXfunds co-founder Jonas Ferris tells you all you need to know about your 401(k) in this handy dandy video from the Fox News Channel. If you have old-fashioned dial-up internet access you'll may want to wait until you're back at work to watch.


Insurance Industry Screws Up Important 401(k) Legislation

June 26, 2007

Participation in company sponsored retirement plans like 401(k)'s increases significantly when workers are automatically enrolled by employers versus having to sign up themselves. The U.S. Government, hoping to encourage savings rates among citizens, wants employers to do just that.

The problem is that companies are worried that if they enroll employees automatically they will get sued by said employees if the market hits the skids. Congress responds by writing the Pension Protection Act of 2006, which protects auto-enrolling employers from 401(k) related lawsuits if those employers offer certain lower-volatility "default" investment options in their 401(k) plans. A list of funds suitable for long term investment was drawn up. And that, says Chuck Jaffe at Marketwatch, is when things get complicated.

...the insurance industry was unhappy with the exclusion of stable-value funds. Stable-value offerings are popular in retirement plans; they are built to provide a set return, guaranteed by the insurer.

While they have a role in some portfolios, stable-value funds are too conservative to be the sole investment option of a worker who is not otherwise saving for retirement. The return may indeed be stable, but it doesn't provide sufficient growth over time. They might be a choice for employers fearing lawsuits about losing money, but the idea of including them as a default choice is anachronistic given the Pension Protection Act's goal of helping more workers to save successfully.

Alas, the insurance industry doesn't seem to care. Seeing its primary retirement-plan issue being cut out of the default-choice pool made the big players green with envy (several firms seem to forget that they have mutual fund arms that operate funds suitable for being the no-pick option).

And so, they started lobbying. They hit the legislators hard, getting them to write the Department of Labor. And the insurers wrote in themselves."

And now the whole thing is stuck in legislative limbo. Sure was a good idea, till greed got in the way.


The Big, Fat, Retire Early Lie

June 25, 2007

Maybe I just watch too much TV, or maybe my eyes open wide whenever I hear questionable financial promises (Ponzi-dar?). Whatever the reason, I can't seem to escape the latest multi-million dollar ad campaign by one of America's largest financial services companies.

The ad starts with a dismal scenario visited upon a baby boomer: relocate or lose your job. Fortunately for the boomer, a brief consultation with a financial expert using sophisticated modeling software showed how early retirement was entirely doable. Goodbye cubicle, I'm going fly fishing, or whatever other boomer financial fantasy (retirement porn) is being used to hustle investment advice.

Not only did the brilliant financial services professional solve this person's dilemma, but, as the advertisement goes on to say, the early retiring boomer's boss called the same professional, wondering if he could retire early too.

The likely problem with the early retirement scenario? It's based on modeling using optimistic investment returns.

In a recent Wall Street Journal article about early retirement, an eerily similar scenario to the one teased in the advertisement is highlighted. Only the real world example uses real world market returns.:

Between 1994 and 2002, brokers from the Charlotte, N.C., branch of Citigroup Global Markets held more than 40 seminars and hundreds of individual meetings with BellSouth workers to show them how they could take early retirement. Central to the brokers' pitch was that the employees could expect to earn 12% a year from their investments and could withdraw about 9% a year from their accounts, according to the NASD complaint.

"You should be able to expect 12%," one broker told a couple, according to the NASD. "That is not guaranteed....We may do 15, may do 18 or 20. But good times, bad times, I think that we would do 12%."

What the workers were not told about was the risk they were taking by cashing out of their pensions, which provided guaranteed payouts, and putting the money in the stock market, where returns would fluctuate. The brokers' materials didn't mention that 12% returns were above the stock market's average returns over the long term -- 10.7% a year over the last 50 years, according to Standard & Poor's.

In addition, NASD said brokers didn't adequately disclose that customers would pay annual fees of 2% to 3% -- and as a result, workers would actually have to earn 14% to 15% on their investments to hit the promises made by the brokers.

When the stock market turned south, the brokers held a series of conference calls to try to hold onto accounts opened by BellSouth early retirees, the NASD said. During these calls, the brokers made various predictions that the markets would soon rebound. One prediction: the Dow Jones Industrial Average would rise to 20000 or 21000 by 2006. (The Dow is now around 13400.) In the end, more than 200 BellSouth employees saw their original investments decline by about $12.2 million, according to the NASD."

These early retirement clients may be fly fishing - but it may be because they can't afford to buy food.

We tend to take the opposite approach as those selling financial services - expect a below historical market return on your investments to make sure you're not broke at 75. If the market in fact delivers double digit returns, great, buy a boat. In the meantime, plan on working and saving more.

Of course, that doesn't make for much of an ad campaign: "I talked to my financial advisor. He said scrap the beach house idea and take a part-time job."


A 401(k) Cost 'Sticker'?

April 23, 2007

We review a lot of 401(k) plans for clients of our MAXadvisor 401(k) Planner service. Some are good, offering a wide variety of high-quality mutual fund investment options. Most, alas, are not. And one of the main reasons why so many 401(k) plans are lousy, writes John Wasik at Bloomberg, is their cost:

Matt Hutcheson, an independent fiduciary consultant based in Tigard, Oregon, says workers are overcharged by as much as 3.5 percent annually. 'Just 1 percent in excess cost to participants represents a wealth transfer of $25 billion to others -- each and every year,' he said.

Some of the most egregious charges are often hidden in retirement-plan documents and involve revenue shared between fund managers and middlemen.

So-called pay-to-play fees also saddle workers with charges that are loaded into your fund expense ratios. For example, a fund company may pay for 'shelf space' or inclusion in a 401(k) plan, also called a platform, says Tim Wood of Deschutes Investment Advisors LLC in Portland, Oregon.

'The participant may be paying up to 0.90 percent annually for a fund,'' says Wood, 'but is not able to determine what fee may have been paid to the platform provider. It is possible that a better option could have been made available to the participant from the entire universe of funds rather than only those that will agree to revenue sharing with a platform provider."

Wasik suggest a 'cost sticker' be included in monthly 401(k) statements that would disclose in an easy-to-read format exactly how much the funds in your 401(k) plan are charging you:

Employers have a huge incentive to open up the black box of 401(k) expenses. At least 16 lawsuits are pending that allege employers and insurers that offered plans failed to disclose third-party fees.

The reason for enhanced disclosure and identifying who is running your plan is simple. The more you know about how much you are being overcharged, the more you can lobby for lower fees. It's called having consumer choice in the free market."

Sounds good to us.


Live a Little

March 7, 2007

A new study says that the Wall Street Industrial Complex is effectively scaring investors into saving more than they need for retirement, because the more money suckers like us invest, the more money mutual funds, brokers, and financial advisers make in fees.

The leader of this counterintuitive challenge is Larry Kotlikoff, a Boston University economics professor and co-author of "The Coming Generational Storm," an analysis of dire solutions necessary to cover future unfunded Social Security and Medicare benefits. His co-author is financial columnist Scott Burns of the Dallas Morning News. Kotlikoff's research says investors should focus on income while working to figure out retirement needs.

Saving too much? You bet. A New York Times review of Kotlikoff's numbers "showed that Fidelity's online calculators typically set the target of assets needed to cover spending in retirement 36.4% too high. Vanguard's was 53.1% too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78%" higher than the calculations generated by Kotlikoff's ESPlanner.

As expected, they were quite defensive about this challenge. The Times says: "The financial-planning industry prefers to characterize itself as cautious. William Ebsworth, chief investment officer of Fidelity Investments' Strategic Advisers division, which runs retirement programs, said, 'We take a very conservative approach,' preferring to err on the side of having money left over at death rather than risk running out before then."

While their reaction is understandable, it's a diversion: They fail to deal with their own conflict of interest and motives in overstating assets needed in retirement.

So let's repeat it again: You are unnecessarily investing too much of your hard-earned money into too many assets for retirement. As a result, you're sacrificing too much of the present, under the highly questionable and misleading assumptions about piling up excessive savings for an uncertain future."


Taxing Issue

March 5, 2007

Here's a simple trick, via Morningstar, that can save you a bundle in taxes, and that a surprising number of investors don't do: put funds with potentially high capital gains distributions in your non-taxable retirement accounts like your IRA or 401(k), and put tax-efficient funds in your taxable accounts:

When a fund realizes capital gains by selling stocks or bonds at a profit or receives interest or dividends, any amount above the fund's expense ratio must be paid out to shareholders, who are then taxed on that income. Some funds are much better than others at shielding shareholders from taxable income and capital-gains payouts. And some investors make it a habit to steer clear of "tax-inefficient funds," those that pay out a substantial portion of each year's gain as taxable income.

When you're choosing a fund for an IRA, though, you can ignore this issue. The attraction of IRAs and other tax-sheltered accounts, of course, is that the profits aren't taxed right away. Instead, they compound until you actually withdraw the money from your account. Only then do you pay the tax. That means some funds you might avoid in a taxable account are suddenly back on the menu when you're investing in your IRA."

They list four example funds that are likely to issue above-average taxable gains distributions and hence would be good fits for your non-taxable accounts:


Think Outside the 401(k)

February 21, 2007

One thing we've learned while reviewing client's 401(k) plans for our MAXadvisor 401(k) Planner service: a lot of 401(k) plans are really lousy. Some offer only expensive or otherwise poor mutual fund options. Other plans lack variety, making it tough to build a well diversified portfolio. What do you do if you need small-cap exposure, but the small-cap choices in your 401(k) are either terrible or non-existent?

A common mistake people make is to balance their 401(k) and to make certain it's diversified among various asset classes," says Gary Schatsky, an attorney, CPA and former chairman of the National Association of Personal Financial Advisors. "It does not need to be balanced. Your investments do."

That means if you have some money to invest outside your 401(k), you can put it to work in the foreign stock fund of your choice and use the money inside your 401(k) plan to get exposure to other asset classes.

Ideally, you can purchase the investments that aren't available in your 401(k) through another kind of tax-deferred account, such as an individual retirement account, to maximize the effect of compounding returns."

And if you decide you need to look outside your 401(k) to build a properly diversified portfolio, a little forethought can save you a bundle in taxes:

One thing to keep in mind when you're looking at your total portfolio is that different kinds of investment returns are taxed at different rates. Interest and short-term capital gains are taxed at rates as high as 35%, depending on an investor's income. But most investors pay 15% on qualified dividends and on long-term capital gains, or the appreciation on an investment held for more than a year.

So it makes sense to put investments that generate the biggest tax bills, such as taxable bond funds or funds that turn over their stock holdings frequently, in tax-deferred accounts.


See also: Ask MAX: Should I Invest in a Loaded 401(k)?

Let’s Hear it for the Good Old IRA!

February 18, 2007

Tom Sullivan reminds us that in a world where 401(k)s are getting all the press, we shouldn't forget about the grand old man of retirement vehicles, the individual retirement account.

Survey after survey shows a heavy majority of people say they will not have enough to live on when they retire. Yet less than half of them say they are putting money into an IRA. Why not? The clock is ticking, and the day of reckoning is coming.

You do not have to contribute money in one lump sum, nor do you have to contribute the maximum amount allowed.

You can put in as little as you want, a tiny amount, if that is all you can afford. You just cannot exceed the annual maximum, which is now $4,000 (or $5,000 for people 50 or older). You can budget it to make a monthly contribution, if that makes it easier on your checkbook.

Don't let the rules on tax deductions sway you against contributing. Many people won't contribute because they don't qualify for a tax deduction. They may already be in another qualified retirement plan, their income is above the deduction threshold or they chose a Roth IRA.

(The Roth IRA, you may recall, is not tax deductible, but all earnings are completely tax-free.)

A tax deduction should not be the main reason you consider putting money into an IRA. You are saving money, and it grows without any current tax liability. The idea is to build a nest egg for the future.

People often ask me whether they can contribute to both an IRA and a 401(k). Yes, you can put money into both."


Regular vs. ROTH IRA

February 15, 2007

Brad O'Neil gives a clear and concise explanation of the differences between a regular and ROTH IRA:

First, a traditional IRA has the potential to grow tax deferred, while Roth IRA earnings have the potential to grow completely tax free, provided you've had your account for at least five years and you don't begin taking withdrawals until you're 59-1/2.

And second, contributions to a traditional IRA may be tax deductible (depending on your income and whether you or your spouse have access to an employer-sponsored retirement plan), while Roth IRA contributions are never deductible.

On the other hand, the traditional and Roth IRAs share some things in common. Both have the same contribution limits ($4,000 in 2007, or $5,000 in 2007 if you're 50 or older) and both can be funded annually with virtually any type of investment - stocks, bonds, Certificates of Deposit."

See also:
Ask MAX: Can I convert my regular IRA to a Roth IRA?
Ask MAX - Are Roth IRAs Too Good to be True?
Ask MAX: A Fee-Free IRA?


Ask MAX: What should I do with my old 401(k)

September 1, 2006

CW asks: 'A while back you helped me with my 401(k). Although it's only been a short time I was very satisfied with your services. I have since moved on to another company and I hope once again you can assist me with my new 401(k) options. Do you have any advice on what I should do with my old 401(k)?'

Would you leave your personal belongings in your old desk? Take your retirement money, along with the pictures of the kids, when you move on to bigger and better things.

The best choice for your old 401(k) is to roll it over into a low-fee broker like Firstrade where you can buy any number of funds, or to a fund family like Vanguard with a wide selection of low-fee funds.

Moving your old 401(k) plan – or 403(b) – is better than leaving your 401(k) at your old employer with their limited selection of often high-fee funds or even moving the old plan to your new employer’s plan, as the new plan will likely have the same shortcomings.

While you can't combine this old 401(k) with a ROTH, you can combine it with other traditional IRAs and maintain the account’s tax-deferred status. The downside of combining it with other accounts is that you can’t move it back to a 401(k) at a later date – it’s been sullied by the other money, so to speak. the rest of this article»

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