That person staring back at you in the mirror has a personal finance plan that is hard to argue with or ignore. Your reflection is probably suggesting to you what it suggested back at the turn of the calendar year: to save more, spend less and focus on getting your debt in line. Intimidated by what is obviously an imperfection in your financial life, you agree. Again. Something needs to be done.
Those mirror conversations are often forgotten as soon as you walk away from your own reflection. And with good reason. Only when you are looking directly at yourself do you see someone who has made these types of promises before. Once the two of you part ways, the reality of past decisions thwarts many of these well-intentioned pledges to do better. The question isn't what is better - that answer we know - it is more like how can you do better?
Improving your personal finances is much easier than you might imagine. So let's look at why your reflection is suggesting an overhaul in the first place. You can't avoid the idea that retirement or at least the time of retirement is closing in, often quickly. You can't dodge the fact that in order to retire at all, let alone comfortably, you need to set aside larger portions of your paycheck. No one has ever told anyone they are saving too much. Everyone, on the other hand will suggest that you and millions of others just like you, aren't saving enough.
In this scenario, they will tell you to max out your 401(k). To do this, the average American with the average paycheck in the average 401(k) can set aside $17,000. This number for this average person amounts to almost a third of their paycheck. And most will agree, this is an austerity measure that will not happen no matter how much the financial profession points out its wisdom. The over 50 crowd can toss another $5,500 into these accounts in order to play catch-up pushing the total contribution in this "maxed-out" situation to almost half of the average wage earners paycheck.
Knowing you are under-contributing often is the first roadblock in doing what you've told yourself you need to do. Resignation sets in and the next time you are in front of that reflection you quip: "I'll never retire" or "I'll just have to work longer". These will, without any argument help you achieve your retirement goals. But in suggesting that lengthening your work life is an adequate solution, you are subtracting from your retirement life. Think of it this way: If the speed limit is 55 mph and you drive 45, you will arrive at your destination; it will simply take longer as as you watch your fellow cohorts pass you, you will become discouraged and this will begin to weigh on the journey.
So forget the limits. Instead focus on the percentages: five percent (5%) of your paycheck contributed and producing a modest return will net you about 25% of the income you currently own, ten percent (10%) will get you about 50% of your current wage while fifteen percent (15%) will get you very close to 75% of what your current income is. Of course you will need to contribute and do so over a span of at least 20-years. But is much more do-able that the whole number that is the maximum contribution.
But even if that is do-able, as I suggest it is, something will have to give. A recent New York Life survey, done as they suggested, across the kitchen table, portrays the average American as someone who will try and manage their debt better. This is translated into spending less. Debt as we all know works against you in many different ways. More than simply spending what you don't have and exceeding what your paycheck brings, the cost of servicing that debt acts as a direct subtracting to that 15% and any return you might get in your plan.
So not only will you need to contribute more but at the same time, you will need to draw down that debt faster. What that reflection in the mirror is suggesting is often too austere for even the most parsimonious among us. Who looks at themselves in the mirror and says: "this year, I live on 30% less." While this might be excellent practice for the retirement you probably will experience, it is quickly dismissed.
Fourteen percent of those surveyed in the New York Life conversation with an agent revealed you will seek help. What you are doing is trading the reflection for a person who will tell you what you have told yourself. Of course this suggests that this financial professional has access to better tools to do what you have promised yourself to do. Ironically, they don't. For a fee, they will tell you what you already know.
Fear might be a motivator and many have taken to making these threats. But fear also brings a natural human reaction: to run in the opposite direction. Comparing where you are now with where you will be because you have done so little so far is a from of this fear. So is comparing you to your cohorts.
The simplest solution: 5, 10, 15. Contribute 5% to your retirement, 10% to your debts and 15% to your mortgage. A five percent contribution to your 401(k) will not impact your take home pay and will probably meet your companies matching contribution. A ten percent increase in payments to your debts will shave years and hundreds of dollars off of the interest you might pay. A fifteen percent payment towards the mortgage principal will reduce the length of your loan by as much as ten years. Doing this will have you arriving at the point of retirement with no debt and no mortgage.
Once the plan is in place and you have done this for five years, begin increasing the contribution by a single percentage point each year. This will be much easier to do as the debt you own is paid off and once the mortgage is satisfied, you will find your reflection congratulating you. This is far better than the criticism it once offered.
Showing posts with label 401(k). Show all posts
Showing posts with label 401(k). Show all posts
Sunday, February 26, 2012
Sunday, January 1, 2012
2012: The six resolutions that matter
This article written by Paul Petillo originally appeared at Target2025.com
Jimi Hendrix once wrote: "I used to live in a room full of mirrors; all I could see was me. I take my spirit and I crash my mirrors, now the whole world is here for me to see." When it comes to the reflection staring back at us, our retirement, like those images, are a search for imperfection. We don't look at ourselves to admire how good we look; we look for flaws. We don't imagine a future; we see the relics of past decisions.
If you consider yourself a Baby Boomer, the reflection in the mirror is an image that polarizes: we are comfortable in the what the future holds or we are worried. There is good reasons for this feeling of either hope or dispair, with no real middle ground. This group has seen the demise of the defined benefit plan (pensions) and the introduction of the defined contribution plan (401(k)). You have seen the greatest bull market in investing history and witnessed two major crashes that have rattled your confidence in the decade following. You are the first generation to realize that your future is in your hands and you were not ready for the responsibility.
If you are younger than a Boomer, you are the first generation to have never seen any other opportunity to finance your future than with a 401(k). And you have come to realize that this is not the plan it was intended to be. 401(k) plans were not designed to be the one and only vehicle for retirement. We were sold a notion that this was the end-all-to-be-all plan that would afford us a better retirement than our parents only to find out that it hinged on two extremely volatile concepts: your ability to consistently earn money and your level of contribution. Your 401(k) became your anchor and your wings.
I imagine that many of you will look back on the highlights of 2011 and find yourself in either one or two camps: you were able to hold onto your job, pay your bills and put some money away for retirement or you will be looking back at a year of indecision, regret and the promise to do better in 2012. You may be celebrating simply getting through it or wishing it never happened. To that, I offer some simple resolutions to embrace in 2012.
One: Revisit your idea of retirement. You can promise to save more money for your future, increasing your contribution to your plan or perhaps, in the absence of a plan, begin one of your own using IRAs. But you do this without really looking at that future. Retirement will not be the same of any two of us. For some it will be a life of struggle, an ongoing effort to make ends meet when they may never met while they were working. For some it will be the realization that the balance between the now and the future relies on a level of personal sacrifice we were smart enough to embrace while we were working. For others, it will simply be a resignation of sorts, a belief that it will never happen.
Retirement is three things: A time when we find new opportunities outside the confines of what we called a career, a place of unimaginable risk and/or a chance to take a breather. It is not a place of no work and all play. It is not a time spent waiting for the end to come. It is not what we imagine because, if we looked closely at that image we see flaws. So we don't look as closely at those who are retired, examine how they live and ask if this is what they had planned. In revisiting the idea of retirement, your concept of that future, consider looking closer. If you don't like what you see, resolve to change it. But don't look away.
Two: Don't reflect on what you've done. You made mistakes; we all have. Some of us took too much risk, some not enough. Some contributed as much to their retirement as their budgets allowed, others did not. Some of us made poor mortgage or credit decisions, others did not. No matter what you did or didn't do, looking back will not improve the look forward.
Looking forward doesn't mean turning your back on on any of those events. It means focusing all of your energy on fixing them. This is a twofold effort, the first being getting the budget you may not have in line with your paycheck and focusing on paying down your mortgage (keep in mind that even if your home is underwater - meaning your mortgage is greater than the value of the house itself - the interest you pay on than loan is eating away at your future invest-able or save-able dollars). Does this mean you should not put money away in a 401(k) plan and redirect every dollar to the day-to-day? Not at all. Keep in mind that a 5% contribution will, in almost every instance, not impact your take home pay.
Three: Don't over think the process. From every corner of the financial world you will hear: rebalance your 401(k). If you chose a minimum of four index funds spread across four sectors, or four ETFs that do the same thing, rebalancing is a waste of time. You diversify so you can capture ups in one market and downside moves in another and your contribution doesn't allow you to buy more when one market moves up and allows you to buy more when it goes down.
We want to think we are in control when in fact, the only thing you actually control is how much money you want to put in. Markets will do what they do best: move. It might be up one day and down the next. It doesn't really matter. What matters is that you do something and in 2012, it should be significantly more than you are doing now.
Four: Stop being selfless. One of the hurdles we are told, for women investors specifically, is their inability to put themselves before their family. This is a cause for concern of course but not a disaster in the making. Take a good long and hard look at your family and ask yourself: could I spend my retirement years living with any of them? Do they want you to?
Five: Embrace the truth. Now there will be an increased amount of pressure from every financial professional to get advice on your investments. This educational effort will evolve in the next several years from long, drawn out seminars on how your 401(k) works to short, ADD friendly videos that last several minutes and offer key points on what to do. The truth still relies on your ability to put more money away. Five percent will net you 25% of your current take home in retirement. A ten percent contribution over the average working career will pay you about 50% of what you earn today in retirement. Fifteen percent contributed to a 401(k) plan with average (modest) historical returns will allow you to live on 75% of your current income. Can you handle that truth?
Six: Stop worrying about it. According to HealthGuidance.org, you are killing yourself with worry. Michael Thomas writes: "Worrying leads to stress and stress has been linked with a number of health problems. People who suffer from high levels of stress are much more prone to cardiovascular disease, gastrointestinal issues, weight problems and there has even been a link made between stress levels and certain cancers." Instead resolve to do more saving than you have ever done, spend less than you did last year and embrace the reality of what fixed income is. Retirement is fixed income. Resolve to live like that now.
Tuesday, November 15, 2011
Don't Know ETFs: Here's the Expert
This past week, on the Financial Impact Factor with Paul Petillo, Dave Kittredge and Dave Ng we had David J. Abner. He is the Director for Institutional Sales and Trading at Wisdom Tree and the author of The ETF Handbook: How to Value and Trade Exchange Traded Funds (Wiley Finance)
These funds, that trade like stocks have been coming to the forefront of the investment world for almost a decade. But even after all that time, their purpose isn't clearly understood, their benefits less so and the media, suggesting volatility has dampened our enthusiasm towards them. Mr. Abner discusses these products, what they are and why they are important. ETFs will begin showing up in your 401(k) as investor demand and plan administrator's fiduciary responsibility tightens. This increase exposure is good for the funds; but are the good for you?
These funds, that trade like stocks have been coming to the forefront of the investment world for almost a decade. But even after all that time, their purpose isn't clearly understood, their benefits less so and the media, suggesting volatility has dampened our enthusiasm towards them. Mr. Abner discusses these products, what they are and why they are important. ETFs will begin showing up in your 401(k) as investor demand and plan administrator's fiduciary responsibility tightens. This increase exposure is good for the funds; but are the good for you?
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Friday, May 20, 2011
Good news/Bad news
While we have all been, on occasion, asked to choose between the good news and the bad news, when it comes to your 401(k), both sides of the question mean something. Today, I'd like to look at some of the good news, bad news that has been coming out of the world of the 401(k).
Investments
Good news: People continue to contribute to their 401(k). A recent Investment Company Institute report found that only 2.4% of investors using this sort of plan did not contribute in 2010. This is considered a generally good statistic for two reasons: the resurgence of the company match may have prompted more people to begin to contribute more in 2010 than they did in 2009 (3.4% ceased contributing) and two, the stock market rewarded these folks for doing so. This means that account balances also increased.
Bad news: Those who did continue to invest actually pulled money from the equity side of the investment equation. The ICI was confused by the pattern, which typically dictates that when the stock market does well, investors tend to increase their holdings rather than withdraw. The shift they suggest may point to a lower risk tolerance which doesn't necessarily explain why there was an increase in international exposure.
Risk
Good news: There is a much clearer understanding of the risks involved in the investment world. Although there are still a sizable number of senior investors (those at least 65-years-old) who are willing to take above average risks with their portfolios, most recognize the danger in doing so.
Bad news: too many younger folks are unwilling to assume risk via equity investments. While 10% of the 65-year-olds reported they take on above average risk, their counterparts in the 35-to-49 age group admitted that they do as well. Defining above average risk is often difficult to do. Related to a balance of investments, with popular sentiment suggesting a gradual decrease in more volatile investments (equities) to more conservative ones (bonds, fixed income), this group may be making these adjustments too soon in their investment lives. If, as popular sentiment suggests that we will work longer, a 35-to-49 age group could possibly be leaving a certain amount of aggressiveness untapped. If you are thinking that you will work until 70[years-old and beyond, a 35-year old should invest in much the same way as 25 year-old would have just ten-years ago.
Better 401(k) choices
Good news: There has been over the last several years, an acknowledgement of sorts from the plan sponsor world that better choices for their participants is directly correlated to the types funds offered. Fees dominated the conversations held by plan sponsors and administrators as those that used their plans turned their focus on how much each investment was costing them. Plan costs eat away at potential returns. So many plans reduced the number of funds offered and with those reductions, the types of funds offered. The shift to a larger selection of index funds and target date funds may have helped create a better investment environment for those using the plans.
Bad news: As fees were lowered amongst the plan's offering, the plan itself became more expensive. This change in how the fees are levied make both the newly low-cost funds offered simply appear as if this were a bait and switch. Fee disclosure will only increase in the coming years as the Department of Labor looks to better reporting of these costs. The trouble is you may not where to look and may be able to little about these costs. You can sue over poor investment choices. But unless you actually leave the company you work for, the 401(k) you have is what you are stuck with.
Bad news: While turnover is often equated with higher fees, a certain amount of this activity is generally considered acceptable if the rate of return is increased as a result. Most investors will shift their money into a fund based on the size. And the larger the fund, the more cumbersome investing becomes and because of that, the lower the turnover.
Target Date Funds
Good news: Target date funds have increased in plan usage from a scant $57 billion in 2000 to almost a trillion dollars invested in 2010. The good news here is limited to the success of the fund families marketing strategies and the required auto-enrollment of new hires. Add to that the financial debacle of 2007-2008 and numerous investors in 401(k)s simply saw the risk in these self-directed plans as too confusing. Turning to target date funds seemed on the surface to be the most logical conclusion for most.
Bad news: Target date funds still have some hurdles to jump through before they gain my seal of approval - no that they are necessarily currying my favor. They remain murky at best. Most target date funds, with the exclusion of those that comprise of index funds only, are a fund of funds. This suggests that a fund family, rather than close a poorly performing mutual fund, simply roll the fund into a target date fund. Because of this, there are still transparency issues. Add to that the suggested target date may not be your target, that no two target date funds are at the same point in investment holdings (risk) as a similarly dated cohort, that there is no fund manager who can offer conclusive evidence that this is the best method of rebalancing and lastly, that most users tend to set-it-and-forget-it.
Fees
Good news: As I mentioned, they have dropped over the last several years. But most investors still make assumptions that fall squarely into the "if it is an index fund, then it must cost less". This lower cost is mostly true and is normally attributed to index funds, even though some smaller index funds that track the S&P 500 charge considerably more than their larger counterparts for the same investment. Even with that in mind, an investor can build not only a well-balanced portfolio using index funds alone, they will do so at a much lower cost than any other investment portfolio in their plan.
Bad news: Most target date funds act as if they can do what they do for less, they don't. Some target date funds have expenses and fees that are well north of 0.80%.
Participation
Good news: more folks are using their options across more age groups and accessibilities. Most mutual funds are held inside 401(k)s by twice compared to those held outside. Add to that the growing number of average to lower income households entering this market for the first time using this sort of investment.
Bad news: Education still has a long way to go. Trusting, finding or using an advisor is still the purview of the more affluent investor. The average balances in these plans increased but it suggests that was a result of an increase in the stock market value rather than an increase in participation or contributions.
Investments
Good news: People continue to contribute to their 401(k). A recent Investment Company Institute report found that only 2.4% of investors using this sort of plan did not contribute in 2010. This is considered a generally good statistic for two reasons: the resurgence of the company match may have prompted more people to begin to contribute more in 2010 than they did in 2009 (3.4% ceased contributing) and two, the stock market rewarded these folks for doing so. This means that account balances also increased.Bad news: Those who did continue to invest actually pulled money from the equity side of the investment equation. The ICI was confused by the pattern, which typically dictates that when the stock market does well, investors tend to increase their holdings rather than withdraw. The shift they suggest may point to a lower risk tolerance which doesn't necessarily explain why there was an increase in international exposure.
Risk
Good news: There is a much clearer understanding of the risks involved in the investment world. Although there are still a sizable number of senior investors (those at least 65-years-old) who are willing to take above average risks with their portfolios, most recognize the danger in doing so.
Bad news: too many younger folks are unwilling to assume risk via equity investments. While 10% of the 65-year-olds reported they take on above average risk, their counterparts in the 35-to-49 age group admitted that they do as well. Defining above average risk is often difficult to do. Related to a balance of investments, with popular sentiment suggesting a gradual decrease in more volatile investments (equities) to more conservative ones (bonds, fixed income), this group may be making these adjustments too soon in their investment lives. If, as popular sentiment suggests that we will work longer, a 35-to-49 age group could possibly be leaving a certain amount of aggressiveness untapped. If you are thinking that you will work until 70[years-old and beyond, a 35-year old should invest in much the same way as 25 year-old would have just ten-years ago.
Better 401(k) choices
Good news: There has been over the last several years, an acknowledgement of sorts from the plan sponsor world that better choices for their participants is directly correlated to the types funds offered. Fees dominated the conversations held by plan sponsors and administrators as those that used their plans turned their focus on how much each investment was costing them. Plan costs eat away at potential returns. So many plans reduced the number of funds offered and with those reductions, the types of funds offered. The shift to a larger selection of index funds and target date funds may have helped create a better investment environment for those using the plans.
Bad news: As fees were lowered amongst the plan's offering, the plan itself became more expensive. This change in how the fees are levied make both the newly low-cost funds offered simply appear as if this were a bait and switch. Fee disclosure will only increase in the coming years as the Department of Labor looks to better reporting of these costs. The trouble is you may not where to look and may be able to little about these costs. You can sue over poor investment choices. But unless you actually leave the company you work for, the 401(k) you have is what you are stuck with.
Turnover
Good news: The turnover rate in the mutual funds offered by your company's 401(k) has dropped somewhat over the years. This is reflective in the choices. Index funds have near zero turnover, rebalancing only when the index shifts. Target date funds tend to shift in a similar way but don't offer the investor anyway of knowing how much is being turned over in the funds within the funds.Bad news: While turnover is often equated with higher fees, a certain amount of this activity is generally considered acceptable if the rate of return is increased as a result. Most investors will shift their money into a fund based on the size. And the larger the fund, the more cumbersome investing becomes and because of that, the lower the turnover.
Target Date Funds
Good news: Target date funds have increased in plan usage from a scant $57 billion in 2000 to almost a trillion dollars invested in 2010. The good news here is limited to the success of the fund families marketing strategies and the required auto-enrollment of new hires. Add to that the financial debacle of 2007-2008 and numerous investors in 401(k)s simply saw the risk in these self-directed plans as too confusing. Turning to target date funds seemed on the surface to be the most logical conclusion for most.
Bad news: Target date funds still have some hurdles to jump through before they gain my seal of approval - no that they are necessarily currying my favor. They remain murky at best. Most target date funds, with the exclusion of those that comprise of index funds only, are a fund of funds. This suggests that a fund family, rather than close a poorly performing mutual fund, simply roll the fund into a target date fund. Because of this, there are still transparency issues. Add to that the suggested target date may not be your target, that no two target date funds are at the same point in investment holdings (risk) as a similarly dated cohort, that there is no fund manager who can offer conclusive evidence that this is the best method of rebalancing and lastly, that most users tend to set-it-and-forget-it.
Fees
Good news: As I mentioned, they have dropped over the last several years. But most investors still make assumptions that fall squarely into the "if it is an index fund, then it must cost less". This lower cost is mostly true and is normally attributed to index funds, even though some smaller index funds that track the S&P 500 charge considerably more than their larger counterparts for the same investment. Even with that in mind, an investor can build not only a well-balanced portfolio using index funds alone, they will do so at a much lower cost than any other investment portfolio in their plan.
Bad news: Most target date funds act as if they can do what they do for less, they don't. Some target date funds have expenses and fees that are well north of 0.80%.
Participation
Good news: more folks are using their options across more age groups and accessibilities. Most mutual funds are held inside 401(k)s by twice compared to those held outside. Add to that the growing number of average to lower income households entering this market for the first time using this sort of investment.
Bad news: Education still has a long way to go. Trusting, finding or using an advisor is still the purview of the more affluent investor. The average balances in these plans increased but it suggests that was a result of an increase in the stock market value rather than an increase in participation or contributions.
Friday, March 4, 2011
Mutual Funds Inside a Small Company 401K
It is a fairly safe assumption that big means cumbersome. We often don’t think of large objects as nimble and marvel at them when they are. When it comes to 401(k) plans however, the smaller the plan the greater the issues facing it. Consider a plan like the one IBM offers. They have four tiers of investments for every level of participant expertise. A plan with as many options as this plan offers might seem as though it would be extremely difficult to navigate the problems that often plague 401(k) plans (compliance and management, fees and overseeing the fiduciary responsibilities). Turns out it is quite the opposite.
In many instances, it is the largest plans that have the most people dedicated to making sure that the liabilities that could occur in these plans, do not. That leaves most smaller plans suspect and your retirement dollars in trouble. Let’s break it down in simple terms.Who’s in Charge?
The larger the firm the greater the chances you will have someone who is dedicated to the plan. They may actually be a retirement specialist, even an attorney who is well versed in ERISA law and compliance. A smaller company will have a greater likelihood of delegating the responsibility to their HR department. The difference in execution can be vast. The larger firm who has experienced people understand the need to review what the plan provider is doing on a regular basis, ensure that the plan is in compliance and the offerings in the plan are suitable for the workforce that use them.
The smaller plan may have too direct a link to the owners of the company. Not that a relationship with the owner has its problems with intimacy, but simply handing down the plan to a staff that might not be as knowledgeable as they should be but versed in the costs of running the business makes for bad bedfellows.
These plans can come with some big problems if this group does two things: relies on the plan provider to check itself for accuracy and execution and believe that they can shave a few pennies off the bottom line. This is not the place to do either of these and failure to do what the plan should can cost the business a great deal more than it would have cost had they done it right in the first place.
Bundled
You might think that, at least on an economic scale, that if you get everything as package, you will save money. In 401(k) plans, this isn’t necessarily the case. When a large firm goes shopping for a plan provider, it knows who its employees are and is concerned with keeping the best for as long as possible. Statistics have proven that the better educated you might be, the greater the use of the plan. Larger companies have a much greater stake in keeping employees using their benefits than do smaller firms. Smaller firms generally try to retain employees through potential.
But when they shop, the don’t go directly to the plan provider as smaller companies do. They enlist the help of a third party administrator or TPA. Yes this adds a layer of costs to the plan but this group also adds an indispensable layer of protection.
With less emphasis on the plan itself, and looking for ways to maximize limited cash resources, smaller firms will often look for bundled type plans. These are bought direct or through an insurance company. And although the emphasize that the products they offer don’t come with the fiduciary responsibility that these plans must have, most small employers and the departments they assigned the plan to, assume they do.
The “Get What You Paid For” Advisor
Small companies, as I mentioned more than once so far, look to cut costs wherever they can. Its understandable. But efficiencies have their limits and those limits can have negative effects in the 401(k). True, they need to manage the costs of the plan so as to make it more attractive to their employees. And true, free seems like a good price. The belief that they can eliminate some fo the costs by not hiring a plan administrator often finds them paying more in fees for the plan that they would have had they simply spent the money in the first place.
Financial advisors need to have experience. If they do not or only have a few plans under their supervision, this is a red flag. In all likelihood, this will lead to compliance problems for the participants, particularly the highest paid employees who tend to use these plans the most.
Why Do I Tell You This?
If you are working at a company with less than 100 employees, the chances are excellent that your boss has failed to do everything she/he could have done to protect the plan and its assets. All you have to do is ask. Ask if there is a third party administrator in place. Ask if there is a financial advisor looking after the investments and is not affiliated with the TPA. Ask if there is attorney involved who is versed in compliance and auditing. these three resources, while on the surface might seem to cost more than they might be worth, act as a system of checks and balances. Call them the product testing team.
If your plan does not have these entities in place, there is a good chance that once the company begins to grow, the plan will begin costing more in the way of employee retention and fees that should have been reduced as the plan grew.
Most folks do not usually think about their 401(k) plan when they look for a job. And once they get it, they often fail to realize some of these problems which could be shaving off potential earnings from the plan. A surprising amount of people don’t even know what or when their vesting in the plan takes place and the smaller the company, the less likely anyone will be able to explain these issues.
Yes, small business is the engine of opportunity in the country and when they grow, all boats rise so to speak. But unless the ship is seaworthy, your “vested” interest in the business could be costing you more than you think.
Sunday, November 28, 2010
Your 401(k) should have been your retirement savior
Despite the metaphors surrounding what retirement planning is supposed to be: a three legged stool, a three pronged approach, whatever visual cue you need to make sense of the process, your retirement is or at least should be, a lopsided financial affair. It should be something that works as a part of whole but not in any sort of equal sense. Social Security and the state of your financial affairs at the time you decide to quit working is really only supposed to be a small part of the retirement plan. In truth, the most prudent people who plan their retirement do so without any consideration of income from any outside source.
Not so in the years following the Great Recession. The vulnerabilities are now something we have seen first hand and many of us have recoiled in horror. Instead of relearning where we went wrong, we looked for the safest rock to hide under. Perhaps that is why, when the latest report from the Investment Company Institute was released this past November, your defined contribution plan or for most of you, your 401(k) was given equal stature amongst the other two "legs" of the retirement stool.
Social Security was designed to help keep those without from becoming destitute in retirement. Not surprisingly, the report points out this use of the program by those who are the least fortunate, the lower paid worker, as more reliant on those benefits than the higher paid worker. As they look at a post-ERISA world (the 401(k) actually came nto being in 1981), they conclude that this has always been the case and if it has, then so be it.
But the study wasn't designed to be much more than a good-old-boy pat-on-the-back. The ICI sees the distance between the demise of the pension as the sole means for retirement among workers in 1974 as a trip worth traveling. Coming out on the other end of that journey finds the lobby arm of the mutual fund industry rather satisfied. they point out that the median income from a defined contribution plan per person in 2009 was $6,000; in those same 2009 dollars, the same median was $4,500 in 1974.
It is not surprise that many of the remaining firms in the private sector still maintain them. But these plans are not considered a reason to work at these companies when it comes to the younger workforce. Pension breed company loyalty while 401(k)s allow workers to shift jobs when a better offer is available. On the other hand, pensions often leave this same group of workers with no retirement benefits, essentially, at least according to the ICI report, when vesting rules and the timing of benefit accural are used as a rodbloack to getting those benefits for time worked.
But during the time frame they used to conduct the comparisons (1975 to 2009), Social Security now makes up a larger share of retirement income even among those who had assets and other income sources. Based on per capita income at either end of the spectrum, with the lowest income group using just 2% of what the study calls asset income with an 85% reliance on Social Security compared with what the higher income group employs (20% assets and 33% of income from Social Security).
While the ICI celebrates the success of the defined contribution plan that replaced the private sector pension and they point out that those with DC plans are doing better than DB plan recipients in the past, one simple fact remains: we aren't doing enough.
While the answers seem clear: you need to invest more - probably much more than you would be comfortable in making, live smaller now while you are working, and hope that your health, inflation or taxes doesn't take a toll on those accumulated finances. In the face of such daunting news, you could expect a pull back. Instead of increased focus, we would get more ennui. Instead of an emphasis on better educated investment and financial decisions, we should expect more use of what we assume of are set-it-and-forget-it investments such as target date funds.
To answer the question in the title: was your 401(k) intended to be complimentary for retirement? I believe the answer was no. It should have been the investment savior, a Wall Street miracle. Trouble is, now many people. financial professionals included are looking for a way to provide the same guaranteed income that those long-shunned pensions provided. And when they do, we will wish it was 1975 all over again because it will come at a much higher cost than we imagined.
Not so in the years following the Great Recession. The vulnerabilities are now something we have seen first hand and many of us have recoiled in horror. Instead of relearning where we went wrong, we looked for the safest rock to hide under. Perhaps that is why, when the latest report from the Investment Company Institute was released this past November, your defined contribution plan or for most of you, your 401(k) was given equal stature amongst the other two "legs" of the retirement stool.
Social Security was designed to help keep those without from becoming destitute in retirement. Not surprisingly, the report points out this use of the program by those who are the least fortunate, the lower paid worker, as more reliant on those benefits than the higher paid worker. As they look at a post-ERISA world (the 401(k) actually came nto being in 1981), they conclude that this has always been the case and if it has, then so be it.
But the study wasn't designed to be much more than a good-old-boy pat-on-the-back. The ICI sees the distance between the demise of the pension as the sole means for retirement among workers in 1974 as a trip worth traveling. Coming out on the other end of that journey finds the lobby arm of the mutual fund industry rather satisfied. they point out that the median income from a defined contribution plan per person in 2009 was $6,000; in those same 2009 dollars, the same median was $4,500 in 1974.
It is not surprise that many of the remaining firms in the private sector still maintain them. But these plans are not considered a reason to work at these companies when it comes to the younger workforce. Pension breed company loyalty while 401(k)s allow workers to shift jobs when a better offer is available. On the other hand, pensions often leave this same group of workers with no retirement benefits, essentially, at least according to the ICI report, when vesting rules and the timing of benefit accural are used as a rodbloack to getting those benefits for time worked.
But during the time frame they used to conduct the comparisons (1975 to 2009), Social Security now makes up a larger share of retirement income even among those who had assets and other income sources. Based on per capita income at either end of the spectrum, with the lowest income group using just 2% of what the study calls asset income with an 85% reliance on Social Security compared with what the higher income group employs (20% assets and 33% of income from Social Security).
While the ICI celebrates the success of the defined contribution plan that replaced the private sector pension and they point out that those with DC plans are doing better than DB plan recipients in the past, one simple fact remains: we aren't doing enough.
While the answers seem clear: you need to invest more - probably much more than you would be comfortable in making, live smaller now while you are working, and hope that your health, inflation or taxes doesn't take a toll on those accumulated finances. In the face of such daunting news, you could expect a pull back. Instead of increased focus, we would get more ennui. Instead of an emphasis on better educated investment and financial decisions, we should expect more use of what we assume of are set-it-and-forget-it investments such as target date funds.
To answer the question in the title: was your 401(k) intended to be complimentary for retirement? I believe the answer was no. It should have been the investment savior, a Wall Street miracle. Trouble is, now many people. financial professionals included are looking for a way to provide the same guaranteed income that those long-shunned pensions provided. And when they do, we will wish it was 1975 all over again because it will come at a much higher cost than we imagined.
Tuesday, September 8, 2009
Good Idea No Matter How You Shake It!
Can President Obama do anything with the GOP jumping down his neck, throwing outrageous accusations and false conclusions? No president will make every constituent happy. There is always bound to be someone, somewhere, most likely on Fox News, to make the argument that the intention of whatever the president plans is against some sort of inalienable right.
In the case of his retirement plan suggestion, the best move in quite a while, the right has paraded all sorts of nationalization rhetoric out, town-hall style to impede the plan.
First, the Plan
In order to get people to invest in their future, something 75 million Americans have failed to do or have done so inconsistently, the president is picking the low hanging fruit first. Most 401(k) plans were designed to allow employees to opt-in. This allowed those who understood what these plans provided to take advantage of them, often to the fullest while leaving those who had no or only rudimentary understanding of the value of these plans on the sidelines.
Creating an opt-out plan will net many of those who have failed to make the effort. By making the contribution to the plan 3%, the tax-deferred investment will not have any impact on an employees take-home pay. If they can see the value of not losing and pay as a result of the effort, there is a good chance they will stay with the plan.
President Obama made no direct calls to Wall Street or to the businesses that offer these plans to simplify them. This is probably, at least in the short-term, a good thing. Oversimplification of these plans will lead to less-risk in an effort to assure these new investors that their money invested will not be lost. This would be too bad and easily rectified by suggesting that these plans invest in the future, not save for it.
Second the Contribution
As many swords are, this one is double edged.
Allowing you to put unused vacation pay into the plan may see less vacation time being taken. But I doubt it. The increased pressures in this sort of economy (ramped up production, less workers with the same work load) make vacation a necessity as never before. But squirreling some away, added to your regular payroll contributions and not going over the annual contribution limits would allow a worker to grab a few more investable dollars that they may not have had. Some companies have a "use it or lose it" policy when it comes to this type of pay. Investing would be a big plus for these folks.
Third, the Tax-Refund
I suspect that this idea will not be used by many people who look forward to that big tax rebate. Often poor and always unprepared, these people have too much income taken from their paycheck each week. Then, as soon as the new year turns, they are pre-spending this false savings, paying off Christmas excesses or simply splurging on something they could otherwise not have afforded. But for those that do take advantage of the plan, this is a golden opportunity to make some money. You do not need a Treasury account or even a bank account; simply check the box on your income tax form.
Fourth, the Rollover Roadmap
Numerous individuals do not understand the importance of a rollover. When it comes to retirement planning, taking a former 401(k) plan and choosing between a rollover to an IRA or taking a lump sum, far too many people take the cash. Economic reasons aside, this is a bad idea. The penalties and taxes seriously diminish the net proceeds and put you years behind when it comes to pinpointing a date when you would like to retire. With any luck, the effort to explain the consequences will mean less folks will do the wrong thing.
Fifth, the Approval
The upsides are numerous. Better access to plans with newer options to put away money for the future coupled with some straightforward talk may just do the trick. There will be resistance, as there always is. But if these folks take advantage of these new options, they, and the country will be set on the right course. The other upside, it can be enacted with Congressional approval.
In the case of his retirement plan suggestion, the best move in quite a while, the right has paraded all sorts of nationalization rhetoric out, town-hall style to impede the plan.
First, the Plan
In order to get people to invest in their future, something 75 million Americans have failed to do or have done so inconsistently, the president is picking the low hanging fruit first. Most 401(k) plans were designed to allow employees to opt-in. This allowed those who understood what these plans provided to take advantage of them, often to the fullest while leaving those who had no or only rudimentary understanding of the value of these plans on the sidelines.
Creating an opt-out plan will net many of those who have failed to make the effort. By making the contribution to the plan 3%, the tax-deferred investment will not have any impact on an employees take-home pay. If they can see the value of not losing and pay as a result of the effort, there is a good chance they will stay with the plan.
President Obama made no direct calls to Wall Street or to the businesses that offer these plans to simplify them. This is probably, at least in the short-term, a good thing. Oversimplification of these plans will lead to less-risk in an effort to assure these new investors that their money invested will not be lost. This would be too bad and easily rectified by suggesting that these plans invest in the future, not save for it.
Second the Contribution
As many swords are, this one is double edged.
Allowing you to put unused vacation pay into the plan may see less vacation time being taken. But I doubt it. The increased pressures in this sort of economy (ramped up production, less workers with the same work load) make vacation a necessity as never before. But squirreling some away, added to your regular payroll contributions and not going over the annual contribution limits would allow a worker to grab a few more investable dollars that they may not have had. Some companies have a "use it or lose it" policy when it comes to this type of pay. Investing would be a big plus for these folks.Third, the Tax-Refund
I suspect that this idea will not be used by many people who look forward to that big tax rebate. Often poor and always unprepared, these people have too much income taken from their paycheck each week. Then, as soon as the new year turns, they are pre-spending this false savings, paying off Christmas excesses or simply splurging on something they could otherwise not have afforded. But for those that do take advantage of the plan, this is a golden opportunity to make some money. You do not need a Treasury account or even a bank account; simply check the box on your income tax form.
Fourth, the Rollover Roadmap
Numerous individuals do not understand the importance of a rollover. When it comes to retirement planning, taking a former 401(k) plan and choosing between a rollover to an IRA or taking a lump sum, far too many people take the cash. Economic reasons aside, this is a bad idea. The penalties and taxes seriously diminish the net proceeds and put you years behind when it comes to pinpointing a date when you would like to retire. With any luck, the effort to explain the consequences will mean less folks will do the wrong thing.
Fifth, the Approval
The upsides are numerous. Better access to plans with newer options to put away money for the future coupled with some straightforward talk may just do the trick. There will be resistance, as there always is. But if these folks take advantage of these new options, they, and the country will be set on the right course. The other upside, it can be enacted with Congressional approval.
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