Are you depositing money each paycheck to your 401(k) account? Up to the match or even beyond that? Each year, I deposit as much as I can, because even after the match, my plan’s S&P fund charges .05%. Let me spell that out, on $100,000, 1% would be $1000, .05% is $50. The account itself also has an $80 per year fee, so on that same $100,000, the total cost is about .13%. My balance is higher than this, so my cost is lower as an overall percentage.

Recently, I became aware of the 12th edition of the 401(k) averages book. I hate when someone ruins a book or movie’s ending for me. Soylent Green? It’s people. Sorry about that. In this case, I suspect you’re not planning to order the book (for $95) so I’ll not worry too much about ruining the ending. 1.08%. That’s the total cost for the average large retirement plan, over 1000 participants. For a smaller plan, the average costs rise to 1.24%.

Ideally, your 401(k) helps you to take pretax money, otherwise taxed at say, 25%, and delay the withdrawal until retirement, when you plan to be in a lower bracket, 15%, or so you’d hope. You see what’s happening here? Your goal is to save about 10%, a bit more with the effect of the tax-deferred compounding. It doesn’t take long for a 1% or higher fee to negate this savings completely. Say you are about to receive $1333 in pay. You have two choices, to deposit it pretax in the 401(k) or to pay $333 in tax, netting $1000 and invest that in a Roth IRA. After 20 years of growth at say, 8%, the $1333 grows to $6213 in the 401(k), but a 1% fee reduces this to 7%, returning $5158. Ouch. After 15% tax, you have $4385. In the Roth account, the $1000 grows to $4661.

The 1% is just an example, actual fees run as high as over 2%, a cost I consider criminal. Little wonder that Broker-dealers up in arms 401(k) fee disclosure. You see, there’s a new rule scheduled to take place on April 1, 2012. It requires disclosure of the fees within all 401(k) accounts. Only, this April, the joke will be on us, as the average 401(k) account charges such high fees that most participants should stop depositing after the match, and a good number of plan providers in the 1.5% and above should probably be sued for not offering reasonable investment choices.

Most advisors agree that 4% is the amount you can comfortably withdraw each year from your retirement account. When the fees are 1% per year, there’s 3% for you and 1% for the fat cat on Wall Street who sold this plan to your employer. Me, I’d rather switch than get knocked out, unlike the guy in this classic cigarette ad.

written by Joe \\ tags: 401(k), Roth

Some days it seems that Murphy’s Law will help the IRS take what they never should in the first place. Two years ago, I wrote an article On my Death, Please, Take a Breath,  sharing the story of a man who inherited an IRA from his sister, and, being afraid of the stock market, cashed it out, creating a hefty tax bill, when minimum withdrawals would have kept him in the 10% bracket at most.

I’m reminded of this as I was answering a question elsewhere (are Elle and I the only readers of Usenet? Hmm).  A woman passed away and left an IRA worth $40K, but no designated beneficiary was listed on the account. This makes the IRA part of the probate estate which is subject to creditors. An IRA that has a proper beneficiary designation will pass to the beneficiary outside of probate and is typically not subject to any creditor obligations, except perhaps taxes due the IRS, especially estate tax. In this particular case, the deceased had obligations of $60K as an individual, so the value of the IRA was completely lost. In this case, there were no fancy tricks  required, no trusts, no expensive lawyers needed. The IRA custodian has a simple form that should be filled out when opening the IRA to avoid this potential loss.

With the end of the year coming up, now is a good time to check your retirement account beneficiaries. If you have any old accounts, it’s a good idea to double check that you set it up properly and fix it if you didn’t. If you are divorced, it’s possible your ex is still listed as beneficiary on an older account. It would be a shame if that were the case and when you pass, your current wife discovers it’s not her money. Perhaps (God forbid) a child has predeceased you, and he or she was listed as the beneficiary. All these situations point toward the need to simplify your finances. If you are retired, you can easily reduce your accounts to one IRA and one Roth IRA, and eliminate the need to chase the paperwork on multiple old 401(k)s or IRAs that were set up at different times.

Do you have a friend or loved one who made a similar mistake? I hope this article can help others avoid this type of costly error.

written by Joe \\ tags: IRA, Retirement

Sometime last year you converted some funds from your pretax IRA account to a Roth. Now, the market is down (The S&P index down about 5% year to date) and you are thinking that paying the tax on the higher value when you first converted isn’t the greatest idea.

Or, you make have realized when you filed your return that the extra taxable income put you into a higher tax bracket. Why pay 25% on that conversion when your regular rate is running at just 15%? In hindsight, it’s easy to look at your return’s ‘taxable income’ line and see where you fall. You can recharacterize just enough to keep you in your original bracket. Don’t forget, you had the option to spread the income over two years, 2011 and 2012 or to take it as income in 2010. If so, you need to look closely at how your 2011 income is doing along with how your investments in the Roth have fared.

It’s nearing the deadline, 6 months after that April 15th Tax Day, or October 17th as October 15th is a Saturday. The clock is ticking!

written by Joe \\ tags: IRA, Retirement, roth ira

It always starts like this – I save (for example) 15% toward retirement, spend 28% on my mortgage, and between Social Security and Medicare 7.65% comes off the top. This is 50% of my income that I won’t have to spend once retired, so a starting point is that I’ll need 50% of my pre-retirement income to retire at the same lifestyle once retired. Add another 20% or so as a buffer for increased medical expenses as I get older, and 70% should be more than enough. Right?

Not so fast, says Dan Ariely, behavioral economist and author of best sellers, Predictably Irrational and The Upside of Irrationality.  In his recent blog post Asking the right and wrong questions Dan suggests that this method (what I call a top-down approach) underestimates the required income for the lifestyle people desire during their retirement. Dan suggests that instead of using the method I started with, that we look not at our current budget and reduce from there, but rather ask the key questions “How do you want to live in retirement? Where do you want to live? What activities you want to engage in?” In Dan’s study (which isn’t shared or linked to, unfortunately) by asking these questions he discovers an average result of 135%.

Let’s take a step back and understand the implications of this. Assuming social security replaces 35% of pre-retirement income (accurate at a $70K income level), then for the 70% replacement, only 35% more is needed, vs 100% as the gap for Dan’s 135% total. This is nearly three times the required retirement savings. If we rely on a 4% withdrawal rate as being safe, it would take 25 times the first year withdrawal as a total amount saved. Just under 9 times your final income to replace 35%, but 25 times final earnings to replace that 100%. Ouch. Considering how low the savings rate is in the US, these numbers are pretty intimidating. I don’t know if these studies serve as a wake up call that we need to save more or if they are just a source of discouragement, showing us how far we are from a satisfying retirement.

What do you think of Dan’s article? How will it impact how you look at what you’ll need to retire?

written by Joe \\ tags: Finance, Retirement, Savings

A few days ago, I saw a tweet that led me to read a CBS article Calif. commish advises teachers give up pensions. The article suggested that the state could no longer afford to pay out on its pension obligations and that changes would have to come. It went on to say that after teaching 35 years, a teacher could expect to get 80% of her salary as a pension each year. Wow! Sign me up, who gets a pension like that in this day and age?

Wait a second. There’s one not-so-minor detail the article conveniently overlooked. These teachers are not in the Social Security system. Another minor oversight – according to a CALSTRS (California State Teachers’ Retirement System) report the teachers still pay in 8% per year of their own money to their pension plan. Now, forgive me, but it’s time to do a little math. In the normal system, one’s employer pays in 6.2% of the employee’s salary to Social Security. Companies’ average 401(k) match is about 3%, but for sake of round numbers let’s assume California puts in a total 8% even, just matching the 8% coming out of the teacher’s pay. So we have 16% per year saved. I pull up a spreadsheet, which will adjust for inflation right till retirement, and enter 16% as the percent saved, a 3% inflation rate, and just an 8% return each year. (Note – Dave Ramsey says I can enter 12% rate of return, but I’ll stick with the 8%) After 35 years, we have 14 times the last year’s income as the amount saved in the retirement account. At 55, an immediate annuity will return 5.82% for a woman (more for a man, we don’t live as long) and to finish the math 14 x 5.82% is…… drumroll…. .816 or 81.6% of final income. No smoke, no mirrors, and just a lousy 1.8% match. My employer gives us 5%, many give more.

What’s ironic to me is that if new teachers simply got this 16% deposited to a private account there’s a great chance they’d actually come out ahead of that 80% income replacement. It comes down to a question of defined benefit vs defined contribution, who will take on the risk? But reflect carefully on the numbers, these teachers aren’t getting a windfall, not by a longshot. Perhaps the author of the CBS article should get, as Paul Harvey says, “The rest of the story.”

written by Joe \\ tags: calstrs, pension, Retirement, teacher