Concerns with 401(k) Plans

I’ve written many times on the topic of 401(k) plans.  They are a truly fantastic tool to save for retirement.  Couple the tax-deferral benefits you get with the  matching employer contributions, in some cases, and you have yourself a potential recipe for retirement success.

However, many 401(k) plans simply lack true effectiveness.  Barring the possible limits on employer contributions, many plans have some glaring weaknesses.  The linked article from Forbes titled, Three Traps to Watch Out for When Choosing a 401(k) Plan is a pretty good, brief article on some important 401(k) topics.

The article’s author addresses 3 main problem areas:

1. Investment Bias
2. Employee Expenses
3. Plan Protection

He emphasizes the importance of choosing an independent advisor (cough cough) to assess and implement a plan because independent advisors (cough cough) are usually investment agnostic in that they aren’t tied to offering a particular product or mutual fund(s).

A 401(k) plan is usually far more expensive than most people think.  See my myriad of posts in my 401(k) section of this site to uncover various blog entries regarding fee issues.  What’s most important to note, from the article’s perspective, is that 401(k) plans have a cost.  And if you’re a participant in the plan, you are paying for the cost.  Whether you want to believe it or not, you’re paying.  Typically, the expense is rolled into the plan assets or mutual fund expenses in some way.  Don’t believe me?  Go look at one of the funds in your 401(k) plan, jot down the ticker symbol of the fund, then go look it up on Yahoo Finance or some other search engine and compare the cost of your fund to what you find in your search.  In some cases, the fund may be the same ticker symbol, but you might notice your fund has additional expenses.  In other cases, your fund’s ticker symbol may represent a different share class of the fund.  For example, you might have a fund from American Funds called the Growth Fund of America.  The standard A share class ticker symbol is AGTHX and carries an expense ratio of 0.68%.  However, a common 401(k) plan version of the same exact fund is an R3 (R stands for Retirement) share class and that expense ratio is 0.97% (ticker sybmol RGACX).

Why the 0.29% difference?  It could be the cost of an advisor, built in expenses to help pay for administration and recordkeeping expenses, or perhaps even something else like custodial fees.  It depends on the situation and circumstances.

Plan protection, in the author’s article, references the various steps an employer can take to make sure the plan is operating efficiently and effectively.  One way is to hire an independent advisor (cough cough) to help with that process.  Formalizing a methodology to monitor the plan costs, funds, and user experience are all ways an employer can help protect himself.

Thanks for reading.

Stable Value Funds Might Not Be So Stable

First and foremost, my apologies to all of you for not spending more time on my blog recently.  Things have been hectic on my end.

That said, I wanted to do a very brief blog entry today on Stable Value Funds.  I’ve written on them before here.  But they are in the news again and I thought it was appropriate to take a second and provide you the following article on Stable Value Funds.

In general, the article summarizes what Stable Value funds are (they are typically found in retirement plans) and one of the problems arising with them…namely the insurance concerns on some investments being used in them.

I hope you find this information valuable.

Thanks for reading.

The Puppet Master?

Ben Bernanke is the head of the Federal Reserve.  Adored by some, loathed by others, the bearded one is the face of our monetary system.  He gets to do really cool things like set monetary policy, determine interest rates and inject money into the economy whenever he feels its warranted (or conversely, pull money out of the economy).

To be a bit more technical, the Federal Reserve (Fed) has 3 major responsibilities:

1. Maximize Employment
2. Stabilize Prices
3. Moderate Long-Term Interest Rates

Yet, Big Ben (as I like to call him) has made reference to a number of other objectives of the Fed.  Namely, he has stated that he would like to see stock prices increase (he has said this numerous times in the past prior to big Fed policies like Quantitative Easing I and II and Operation Twist).

And like any good puppet master, when Big Ben pulls on the strings of the market, it dances.  Does it ever.

Take, for example, a recent analysis by Doug Short – a guy who puts together, what I feel, are some of the best charts/analyses you can find.  Mr. Short has assembled a great visual which illustrates how the stock market (S&P 500) reacts when the Fed steps in and either pumps money into the economy, changes interest rates or performs the tricky Operation Twist – a system by which short term bonds are sold to buy longer term bonds in an effort to keep interest rates low.  Note how the solid blue line trends upwards when these big undertakings are in effect.  For his full analysis, click here.

Amazing stuff…well, if you’re a geek like I am.

Personally, I feel the Fed actually has too much power.  Of course, I completely understand the other side of the argument which states that, without the Fed, we’d be more prone to economic collapse and have more volatility.  It’s just that I would argue the opposite – Fed intervention has contributed to large bubbles and huge volatility swings.  The housing market being the best and most well-known example by which nearly everyone has been impacted.  But this isn’t an economics or political science course.  This is just my little blog where I post interesting information.

And today, that information seems to show us a little about how stock prices have reacted to Fed intervention in recent years.

What will be truly interesting to watch is what happens when “Operation Twist” ends in June of this year.  Will the stock market retreat?  If so, what strings are pulled by Big Ben and the Fed?

Does Your Debt Die When You Do?

When setting up a financial plan for yourself, it’s always best to look at your debt situation and ask yourself if your heirs will be forced to “inherit” your debt in the event of your death.

Unless you have no loans to your name, this is probably an issue you want to address with considerable time and thought.

Generally speaking, if you have no heirs, relatives or have no debt that is co-signed, your debt will die with you.  However, if you have debt in a joint name, for example, there’s a very real possibility that you could transfer your debt to your joint account holder.

Let’s take a look at an example to clarify this.  Let’s say Mr. and Mrs. Smith are both 55 years old and have a mortgage, held jointly, that started in 1992 at an interest rate of 5% and a term of 30 years and an original value of $150,000.  Now let’s say that Mr. Smith passes away in March of 2012.  The mortgage company simply won’t absolve Mrs. Smith from having to pay the remaining ten years of debt because Mr. Smith died.  Conversely, they will continue to seek repayment of the loan on the already-agreed-upon terms.  In case you were wondering, without taxes and insurance, the monthly payment would be $805.23.

Now, if Mr. and Mrs. Smith haven’t addressed this issue already, Mrs. Smith could be in for a very difficult time ahead.  The easiest and most obvious way to address this is if Mrs. Smith is making enough money on her own to cover the monthly payment.  But another very easy way to handle the situation would be to acquire life insurance to cover the value of the loan (be aware of potential tax implications if the value of the life insurance policy is too high – it might trigger an estate tax).  Had Mr. and Mrs. Smith each taken out a $150,000 loan in each name at the time they purchased the home, they would have ample funds via the life insurance payout to take care of the debt in the event of death.  They could even reduce the amount of coverage they need as they pay down the debt so they aren’t over-insured – saving them money in the long run.

If you die and your assets are greater than your liabilities, your estate will probably be forced to settle up with any creditors.  Of course, the terms of this can vary by state and may or may not apply given the situation.  But, as a general rule of thumb, if you have assets that exceed your debt, you can probably bet that the creditors will look to get what they can from your estate.

As a general guideline, a quick, easy way to make sure your heirs aren’t stuck with a loan that could bankrupt them, life insurance is always a possibility.  Upon death, proceeds will be paid to your beneficiary.  In the case of Mr. and Mrs.  Smith above, Mrs. Smith will receive an insurance payout from Mr. Smith’s insurance company which she can use to pay off the debt entirely, pay down a portion of it or use it for something else.

For anyone who is forced to deal with the pain of losing a loved one, you might also find yourself dealing with the pain (in the *ss) of debt collectors.  You might not even be required by law to repay the debt of your recently deceased loved one, but they’ll probably try to get you to do so.  It’s best to check with a financial professional or attorney on these issues to help you (preferably an attorney so they can fight back on your behalf if the debt collectors decide to be really obnoxious).

Remember, debt doesn’t have to be an added burden to your heirs.  The titling of accounts properly, the proper structuring of debt and the use of life insurance are all good ways to help make life easier on your loved ones when you pass.  Take some time to figure out what is best for you and your family before it’s too late.

For more information on debt management, please read the following article from CNBC or contact a financial professional or attorney.

Taxes, Taxes and More Taxes

Uncle Sam Wants You…and your money.

It’s that time of year again when people worry about their taxes.  A recent study showed that the tax deadline is one of the most stressful, feared days of the year.

I could easily hop on my soap box and talk about how awful the current tax system is and how it could be improved through a variety of ways, but I won’t…even though I kind of just did.

If you’re one of the many who hate this time of year, fear not.  There are a variety of strategies you can utilize to help reduce your tax burden.  Of course, the best way is to consult your tax advisor for advice, but the following are some generalities that are commonly used to help reduce tax burdens for many people:

• Contributions to an IRA or your company retirement plan.
• Contributions to an education savings plan – Many states offer a tax credit or deduction for contributions to educational savings accounts such as a 529 plan.  The bad news here is that you generally have to contribute by the end of the calendar year, not the tax filing deadline as is the case for IRA contributions.
• Charitable contributions – the IRS generally allows a wide variety of charitable contributions to be used as deductions on your taxes – church contributions, donating to Goodwill (or something comparable), or other non-profit organizations, for example, are good ways to reduce your tax burden.

These are just the basic, easy deductions people can generally use.  You might have business expenses, special tax incentive savings opportunities (like energy efficient enhancements to your home) or a variety of other deductions or credits you can utilize.  Check with your tax advisor and see what you can do to help reduce your tax obligation.  Chances are, you’ll probably be able to take advantage of some really good tax provisions.

Collective Investment Trusts

401(k) plans can utilize a variety of investment options.  Collective Investment Trusts (CITs) are one of those many options.

Investor Words defines a collective trust as such:  an investment fund formed from the pooling of investments by institutional investors.

In short, it’s like a mutual fund, but it only sells itself to institutional investors such as 401k plans, for example.

So, is a collective trust better than a mutual fund and should you want it in  your 401k plan?  Not necessarily.  There are some unique differences, however.

CITs can bypass some of the regulatory requirements of traditional mutual funds.  Generally, you won’t be able to find info on a CIT by looking up a ticker symbol online or in a newspaper.  Additionally, they are not required to distribute dividends.  They are generally rolled directly back into the investment and added to the fund’s NAV (net asset value – which is basically the price of the fund).  In fact, this can be cost efficient for the CIT.  Without having to track or pay out dividends, it’s an administrative cost saver.  This can help reduce the fees of the CIT.

Fees tend to range from slightly lower to slightly higher than an equivalent mutual fund offering.  So there may or may not be an advantage in that regard.  However, fees can be very controlled in many cases.  The key reason is the term “collective.”  For example, a 401k vendor that utilizes CITs can pool all of the assets from a group of 401k plans that all want to pursue a particular strategy – wanting to track the S&P 500, for example – and combine all of those assets into the CIT.  Doing so can help reduce costs.  This makes it advantageous for some users.

Of course, there are some things that might be considered negative.  Because there isn’t a ticker symbol, it can be difficult to find info on the CIT outside of your 401k plan.  Also, CITs are not required to publish their holdings (investments).  Last, but not least, a prospectus generally isn’t provided.  These might be reasons some would consider CITs a poor investment choice.

For more info on CITs, I would recommend reading Vanguard’s overview on them.

Variable Annuities in 401(k) Plans

Instead of writing up my own blog entry about variable annuities in 401(k) plans, I thought this article did a fairly decent job of summarizing.

I agree with pretty much everything the author has said regarding variable annuities in 401(k) plans:

• They are expensive
• Surrender charges can be damaging
• The death benefits are usually over-hyped and not all that beneficial to people.

If you’re an employer offering a 401(k) plan to your employees, please read the above-linked article and take a few minutes to assess whether or not variable annuities in your plan are worthwhile or appropriate.

Punishing Those Who Save? Or a Lesson in Fairness?

President Obama just released his new budget proposal the other day.  One of the areas of discussion was retirement savings.

In his proposal, the President stated he would like to phase out the tax incentive for saving in a retirement plan for those families making over $250,000 per year (individuals over $200,000).  In short, the amount of deduction a person/family can get is reduced over the aforementioned threshold.

He also called for the introduction of automatic IRAs for workers at companies that do not currently offer a 401k plan.  The following is an excerpt from the above-linked article:

Under the proposal, businesses that didn’t already offer a plan would be required to enroll their workers in a direct-deposit IRA compatible with existing direct-deposit payroll systems. Workers would have the opportunity to opt out if they preferred.

Business with fewer than ten employees would be exempt from this requirement and he is calling for an increase in tax incentive for the small businesses of an additional $500 (from $500 up to $1,000).

Of course, the debate has already begun on the prudence of such a plan.  Why prevent those who can save from saving via less favorable tax treatment relative to the rest of society?  Conversely, some applaud the efforts because now the little guy will get a shot at saving, too.

In my opinion, this is nothing more than posturing.  IRAs and company sponsored retirement plans already exist for the “little guy.”  They have as much incentive, if not more, to save as their higher income-earner counterparts.  Why?  The amount of deduction is far greater as a % of income and will be more likely to reduce their tax bracket as opposed to higher income earners.

The real issue here is how do we get people to save and see the value in doing so.  Adding more regulations, reducing tax breaks for higher income wage earners and requiring companies to abide by new IRA laws doesn’t do anything to solve the actual problem.  What is that actual problem, you ask?  The education of what saving means in the long run AND the economics of being able to do it.

But stay tuned.  I’m sure this argument will get ugly in DC.

How Do YOU Pay for Advice?

The Wall Street Journal has a not-so-bad article they put up a little over a week ago regarding advisor fees.

If you’ve read my blog at all, you no I harp on fees quite a bit, but this article takes a little bit different approach and looks at the various fee models different financial professionals can utilize when working with clients.

As is the case with everything you buy, you should know how much you’re paying and what product/services you’re getting.  This article, though not A+ material as I feel it doesn’t include a couple of important concepts, does a pretty admirable job in summing it up for people.

How to Pay for College

If you read my last post about education costs, you know that the national inflation rates for colleges is up to around 8% annualized.  That’s more than twice the rate of our current inflation.  That means that it’s extremely difficult to save enough money for college.  So how does one pay for college?  Let’s review…

There are generally three options to pay for college – saving money, receiving a scholarship and applying for financial aid/loans.  I’ll review each of these with you.

Save:  Saving can be done in a variety of different ways – mostly through various education savings accounts – but the most popular of which these days is the 529 plan.  Because of the popularity of these plans, I’ll focus on them for a minute.  529 plans are nothing more than a fancy term used for college savings accounts whereby you contribute money to the account for a designated beneficiary (the future student) and the money in the account can be invested and grow tax-deferred and tax-exempt if the money is used to pay for college expenses.  To entice college savers, each state has adopted their own set of tax laws that might make it advantageous to contribute to a 529 plan.  In Indiana, for example, you receive a tax credit for the amount you contribute to a 529 plan in the amount of 20% of your total contribution in a year up to $5,000.  Let’s say you put $5,000 aside in a 529 plan for your daughter.  You then get a $1,000 tax credit on your annual tax return (20% of $5,000).  The money grows tax-deferred (tax-free if used for college expenses) and the beneficiary doesn’t even need to be a blood relative.  You can contribute to your next door neighbor’s cousin’s, step-dad’s grandson if you want.  As stated earlier, each state has their own tax laws, but they also have their own version of a 529 plan.  Some state 529 plans are designed so poorly that the tax benefit in the state doesn’t outweigh how poor or expensive the investment options are – which can negate the impact of the tax savings.  Because I’m in Indiana, I’ll include a link to the 529 plan Indiana has adopted:  Indiana 529 plan.  If you’re not in Indiana, you can simply do a Google search to find your state’s 529 plan.  One important downside to a 529 plan – if you pull the money out without using it for college education expenses, the money can be taxed and then penalized an additional 10%.

Scholarship:  If you’re lucky enough to be awarded a scholarship, either through athletics or academics, this is a major help in paying for college.  Aside from the obvious athletic scholarships that are awarded to student-athletes who excel in a particular sport, academic scholarships are quite common as well.  In fact, it’s possible to receive a partial scholarship if you’re not lucky enough to get a full ride.  Each college/university will have a financial aid office who can direct you to possible scholarship opportunities for which you can apply.  It’s easy enough to contact a university’s financial aid office, but to get you started (for the state of Indiana), here is a list of scholarships available. Additionally, the Online Education Database (link is for Indiana, but you can search other states in the database) has some info on scholarship availability.

Loan/Financial Aid: The last option, unless you count winning the lottery as a legitimate option, is to apply for a student loan.  Some people refer to it as financial aid (which is also a term used for a scholarship), but I’m specifically referring to loans here.  Each college/university has a loan process you can go through to get approved.  Primarily, these are federal loans, though some institutions might have their own lending process (private loans).  Federal loans are relatively easy to get and offer repayment terms that typically start about 6 months after graduation.  Make sure you find out the specific details of the federal or private loan for which you’re applying.  There is a pretty big downside to getting a loan, though.  In the event the college grad falls on hard times after college and can’t repay the loan, bankruptcy offers no protection as it does from other creditors.  In some cases, if a person dies with a balance on a student loan, that balance transfers to the family to pay.  A nice safeguard to take if you have substantial student loan debt over your head is to get life insurance enough to cover the debt so that the surviving family members aren’t burdened with the payment of the student loan (if the student loan you have transfers to the surviving family members upon death).  As with any loan, it is important to know and understand the terms.  Important questions to ask yourself are:  Does the loan transfer to surviving family members upon death?  How long (how many years) is the repayment plan?  What is the interest rate?  Does it offer a forbearance if you need one?  How much per month will you be able to afford after graduation?  These are all important questions to ask when analyzing a student loan program.  Whether it be a federal or private loan, know your responsibilities and options.

Of course, you can always go to your local gas station and spend $1 on the winning lottery ticket.  College costs, then, are of no real concern.

I hope this has been of some value and help to you.  Good luck!