Fidelity cuts its minimum holding period for NTF funds

After a quiet couple of years on the brokerage front, Fidelity unexpectedly shook things up this month. The big change: Fidelity cut its minimum holding period for NTF (no-transaction-fee) funds from 180 days to just 60 days. This is a significant shift in the landscape.

When we last updated our broker rankings two years ago, Schwab and Scottrade earned top marks, largely because of their 90-day holding periods for NTF funds. TD Ameritrade and Fidelity (and Vanguard) required an 180-day hold, which was a substantial handicap. SMI rarely sells a fund within 90 days (and never within 60 days), but 180 days isn't out of the question.

With this move, Fidelity moves to the front of the pack in the brokerage race. It now has the best NTF policy (rather than the worst). This impacts costs dramatically also, as their $75 short-term trading fee was a big deal before, but now will rarely ever come into play. Their $75 transaction fees look higher than Schwab's at first glance, until you realize that you only pay the $75 on one side of the transaction at Fidelity, as opposed to Schwab's $50 fee applying on both the buy and sell. So it's actually cheaper than Schwab on that score. And Fidelity already had a slight lead in fund availability.

Schwab has also tweaked their transaction fee fund pricing as of December, so the big boys seem to be going at it. That's good for investors.

We'll likely revamp our Brokerage Ratings in an upcoming newsletter, given that Fidelity is vaulting into the top position with this change. The key question: will Schwab (and/or any other competitors) make any changes of their own in response? Stay tuned.

Inflation History: The Rise and Fall of the U.S. Dollar

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Category(s): Retirement
Tag(s): Fidelity, holding periods, NTF, Schwab

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Charles Ponzi in the 1920s, Social Security in the 1930s

After reading my cover article pointing out the outrageous truth about Social Security ( Members Only), the two leading contenders for the Republican nomination for president immediately began arguing over whether to call the program a Ponzi scheme.

Ha, just kidding! Doubt either Mitt Romney or Rick Perry have taken time out of their busy schedules to devour the latest issue of SMI. But I found it interesting to read that the Ponzi comparison has a long history:

Not only have a raft of conservatives called Social Security a Ponzi scheme over the years, quite a few very respectable liberals have done so as well.... Jonathan Last has already identified a 1967 Newsweek column by liberal economist and Nobel laureate Paul Samuelson as perhaps the earliest use of the Social Security/Ponzi-scheme comparison in public argument. Samuelson was actually drawing on the Ponzi analogy to defend Social Security. His claim was that the perpetual succession of human generations establishes the conditions for a sustainable Ponzi scheme. Regardless of whether Samuelson was the first commentator to use the Ponzi analogy, he has clearly been the most influential. Policy briefs and books churned out by conservative think tanks such as Heritage and Cato have cited Samuelson’s Ponzi column for years. This is likely how the comparison made its way into public debate.

It's a natural analogy because SS's structure has always relied on supplying new contributors to the system to pay the benefits of the earlier contributors. When you no longer have enough new contributors, the scheme collapses. Good deal for those in early; bad deal for those in late. As SmartMoney points out in 10 Things Social Security Wont Tell You:

Today's workers -- boomers, Gens X and Y -- like to carp about Social Security, but it's not all sour grapes or skepticism about paying into a system with an uncertain future. Employees today pay more in Social Security taxes than previous generations did. They're also likely to get smaller benefits when it's their turn to retire....

For example, a single man who retired in 1980 at age 65 after earning an average wage of $43,500 would have paid about $96,000 in Social Security taxes, and probably received $203,000 in lifetime benefits, according to a study by the Urban Institute, a non-partisan policy think tank in Washington D.C. By contrast, a single man making the same average wage today and retiring in 2030 will likely pay $398,000 in lifetime taxes but receive just $336,000 in lifetime benefits -- about 16% less than he paid in. "People who were first in the system got a great rate of return," says Alan Gustman, chair of the economics department at Dartmouth College. "It's the younger generation that is going to be in the most difficult position."

Of course, Charles Ponzi (and other infamous villains such as Bernie Madoff) constantly needed to find new sources of money to keep things moving along. The U.S government took a simpler route—passing a law making SS compulsory for most of us. Noting the similarities in approach (if not enforcement mechanism), even Mitt Romney has compared those managing Social Security to criminals.

Whether one labels SS a Ponzi scheme or not, it's been obvious for a long time that the program is not self-sustaining and needs to be reformed. Hopefully, the current "crisis" environment regarding the federal debt will provide Washington with the needed backbone to take constructive action.

Need a better understanding of Social Security? Download our special FREE report: IRAs, 401(k)s and Social Security: A Retirement Planning Primer

IRAs, 401(k)s and Social Security: A Retirement Planning Primer

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Category(s): Retirement, Taxes
Tag(s): investing, ponzi scheme, retirement, social security

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The impact of aging on your financial decision making

Closing out last week's Morningstar investment conference was Harvard's Robert I. Goldman Professor of Economics David Laibson. He tackled the unpleasant but important topic of cognitive decline among the elderly and the impact it has on their financial and investing decisions.

Combining information from this summary of Laibson's address as well as this follow-up interview following the address, here are some of the highlights that stood out:

Laibson highlighted two kinds of intelligence. Crystallized intelligence is the ability to accumulate wisdom, experiences, skills, and knowledge. This type of intelligence rises until age 60 when dementia is more likely to set in. Fluid intelligence is the ability to solve new problems. This type of on-the-fly intelligence peaks at 20 and then declines rapidly.

According to memory and analytics tasks performed by all age groups, 80-year-olds perform at the bottom 16th percentile. Moreover, age is a greater hindrance to economic rationality than is being low-income or of low-education. As a result, the retired are among the most impaired in terms of economic reasoning. The prevalence of dementia (or cognitive impairment) plays a huge role. Laibson noted a startling but compelling statistic — the likelihood of developing dementia doubles with every five years of age after age 60.

Unfortunately, in the 80s, about half the U.S. population either has full blown dementia or cognitive impairment, which is short of dementia, but still a clinical diagnosis — half the population. So, every investor in their 60s should be preparing for the possibility, an enormous possibility, that things are going to go badly in the 80s.

Laibson says that risk-adjusted returns for investors in their 80s run about 3% below "baseline" (which I don't see precisely defined, but from context seems to indicate what other investors of other ages get when investing with a comparable set of goals). This also helps explain why 20% of American seniors report being taken advantage of financially.

Laibson's primary point is that investors need to plan ahead for the potential that cognitively they just may not be as sharp in their 80s as they were in their 60s. Naturally, people aren't always aware of the decline as it happens, which makes planning ahead for it crucial.

In terms of investing, Laibson's opinion appears to be that all "complicated" aspects of your investment strategy ought to be wound down (or on a very specific, written plan made out years in advance) before an investor reaches these ages.

There are other applications as well. One important one is in the area of estate planning and making sure the four primary estate documents are in order while you're still relatively young.

What are those documents? You should have a durable power of attorney or a springing power of attorney. You should have a living revocable trust that protects your assets. You should then have two health-care documents. A health-care proxy, that basically assigns someone to help you make health-care choices if you are no longer mentally competent, and you should have a living will, which is providing instructions to that person about what kind of care you'd like. How extensive intervention do you want if you are, say, on life-support.

While this isn't a pleasant topic, it's an important one. Reading one or both of the links above is probably time well spent. Beyond that, putting in the effort to simplify your investing/financial decision-making as you get older is smart. Think of it as doing a favor for your older, potentially less-capable self. If none of this decline happens to you, you still haven't lost anything, as your financial plan will be that much more organized and well thought out.

That's a benefit worth working for at any age.

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Category(s): Investing Principles, Retirement
Tag(s): aging, financial decisions, retirement

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"Plan for retirement? I'll do that later"

The Wall Street Journal's Real Time Economics blog reports on a "working paper" from the National Bureau of Economic Research that finds that many Americans are remarkably ill-informed and ill-prepared financially.

The paper, based on 2009 data and authored by economist Annamaria Lusardi of the George Washington School of Business, is titled "Americans' Financial Capability." The WSJ presents some of the key findings:

– When given a basic list of questions on economics and finance in everyday life, less than 10% of respondents are able to answer all questions correctly.

– Half of survey respondents said they had trouble keeping up with monthly expenses such as bills. Only [about] half of those surveyed...had rainy day funds set aside that would cover them for three months in the event of a severe loss of income, such as a layoff or illness....

– As much as a quarter (23%) of those surveyed said they have used some flavor of high-cost borrowing, such as a pawn shop, advance on tax refund or payday loan....

– "[T]he majority of Americans have not done any retirement planning," Prof. Lusardi writes. Only 42% of those surveyed said they have tried to figure out how much to save for retirement....

– When respondents [who had retirement accounts] were asked [if] their retirement savings were invested primarily in a target-date fund, 37% said they didn't know the answer....

– [A]bout one in ten (9%) of respondents who have a retirement account such as a 401(k) or IRA said they tapped their retirement savings. Most of those withdrawals were seen among those earning between $25,000 and $75,000 a year....

– About 20% of consumers surveyed who had auto loans didn't know the interest rate they pay. Of the 46% of credit-card holders who carry a balance, 12% didn't know the interest rate on the card in their wallet with the largest balance.

Back in the days when it was much more difficult to get financial information than it is now, it may have been understandable that many people were in the dark about financial matters. Today, such information is widely and freely available. It is a shame that so many Americans stay willfully ill-informed about things they need to know for their own good — and for the good of society.

By the way, economist Anna Lusardi, who authored the paper reference above, runs a blog titled, "Financial Literacy and Ignorance." The subtitle is: "What do people actually know about personal finance? Not much, it seems."

Don't let that describe you!

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Tag(s): personal finance blog, preparing for retirement, rainy day fund

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401(k) loans and 2nd mortgages

Shocking: almost 30% of 401(k) savers have a 401(k) loan outstanding.

I'm speculating here, but I suspect the type of faulty analysis presented in this article is one reason that might be the case:

RambergMediaImages via Flickr

What is more, with interest rates so low and the stock market volatile, a 401(k) loan can offer a decent rate of return. An investor who took a $25,000 loan five years ago at 6% interest would have paid himself about $4,000 in interest about the same return as if he had invested in a Standard & Poor's 500 stock index fund for the same period, without the crash-induced stress.

For borrowers who use the money to pay off high-interest debt, the effective return can be greater, thanks to the savings they get by replacing it with the lower-interest loan.

Wrong. Sure, the balance in the 401(k) might be the same whether the $4,000 in interest came from the borrower's checking account vs. appreciation in the stock market. But their overall financial condition isn't the same.

In the case of the non-loan, their checking account is untouched, plus they've gained $4,000 in appreciation within their 401(k). In contrast, with the 401(k) loan, their 401(k) balance is the same, but their checking account is $4,000 lower due to the interest they've had to pay into their 401(k) plan. So in total they are $4,000 poorer!

Naturally, they got the $4,000 loan in the first place, which theoretically offsets the $4,000 hole in their checking account. But in too many cases, that money is spent on stuff the person wouldn't otherwise borrow for if they realized that borrowing from their 401(k) really isn't much different than borrowing the money from the bank. Too often, articles like this one make it seem like 401(k) loans offer something for nothing. Not so.

The idea that borrowing from yourself is somehow free is an illusion. As we pointed out in early 2009, borrowing from a 401(k) might be a reasonable idea if you are absolutely going to have to borrow anyway. Otherwise, it's usually a bad idea.

Related: those with 2nd mortgages are more than twice as likely to owe more than their house is worth than those without 2nd mortgages (38% vs. 18%).

What do these items have in common? Both 401(k) plans and home equity used to be regarded by most people as more or less "untouchable" savings. Somewhere along the line that changed and many people started using these reserves to supplement income. That has proven to be a big mistake.

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Category(s): Current Market Events, Retirement
Tag(s): 401(k) loan, borrowing from a 401(k)

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How NOT to handle wills and inheritances?

I just read this fascinating piece on how one man structured his will nearly 100 years ago.

The article tells how early-20th-century multimillionaire timber baron Wellington Burt (pictured below) decided to go about leaving his fortune:

1) Ultimately, his money would be fully distributed to his family — but only 21 years after the death of his last surviving grandchild.

2) In the meantime his "favorite son" would get $30,000 a year but the rest of his children (and grandchildren) would get allowances roughly equal to those he gave his cook and chauffeur.

He did this under the guise of not "risk[ing] messing up his kids lives with a huge inheritance," according to a related article in The Wall Street Journal. But surely there was a better way — one that would strike a balance between the extremes of leaving a huge inheritance all at once and effectively skipping over two generations of his family.

Burt could have given all the children (except those who were clearly irresponsible) a reasonable amount yearly, perhaps requiring that they worked productively in the family business (or otherwise contributed productively to society). Or, in an effort to encourage generosity, he could have given them "x" dollars a year of which half had to be given to a charity. The options were limitless.

The WSJ article goes on to say, "Of course, skipping a generation is not unusual among rich parents who want to send a message to their kids (but somehow not their grandkids)." I think that's an interesting point, about the grandkids somehow escaping "the message."

Don't get me wrong, I don't have an issue with spreading out an inheritance to grand, great-grand, great-great grandchildren, and so on. And, obviously, I don't know all the details of Mr. Burt's situation. But it seems to me the whole process could have been set up in such a way as to stimulate generosity, hard work, and accountability.

I think that's the goal of these verses in the Book of Proverbs:

13:22 - A good man leaves an inheritance for his children’s children, but a sinner’s wealth is stored up for the righteous.

17:2 - A wise servant will rule over a disgraceful son, and will share the inheritance as one of the brothers.

20:21 - An inheritance quickly gained at the beginning will not be blessed at the end.

Had it been available, Wellington Burt would have surely benefited from Ron Blue's book Splitting Heirs: Giving Your Money and Things to Your Children Without Ruining Their Lives (maybe you would too?).

So let's suppose you have a multimillion dollar fortune to leave behind (or perhaps something much more modest): How would/will you structure it? If you have any "disgraceful" children (which I'm sure you don't, but apparently Mr. Burt did), would you omit them from your will? Do you like Mr. Burt's estate plan? What would you change about it?

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Category(s): Family Finances, Retirement
Tag(s): estate planning, inheritances, wills

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You can still turn an IRA distribution into a donation

Tax provisions don't die easily. Several years ago, Congress authorized a "temporary" provision that allowed holders of traditional IRAs — if over age 70½ — to donate as much as $100,000 directly from their retirement account to a qualified charity tax free.

This was a win-win for affluent taxpayers and for charities. The taxpayer could avoid a tax bite on a required minimum distribution (or RMD), and the charity would likely get a larger donation. It was nice while it lasted, but that provision expired at the end of 2007.

Oh, wait. It came back — "temporarily" — for tax years 2008 and 2009. Then it ended.

No, wait. Under the tax-deal legislation signed last month the distribution-into-donation provision is back once again, made retroactive for 2010 and extended through 2011.

Here's the latest from the IRS:

The qualified charitable distribution [QCD] provisions were renewed for 2010 and 2011, allowing individuals age 70½ or over to exclude from gross income up to $100,000 that is paid directly from their individual retirement accounts (excluding SEP or SIMPLE IRAs) to a qualified charity.

The excluded amount can be used to satisfy any required minimum distributions that the individual must otherwise receive from their IRAs for 2010 and 2011. The deadline for making a 2010 QCD is January 31, 2011.

In other words, you have about two-and-a-half weeks left to donate directly from a traditional IRA to a charity and count it for tax year 2010 (and remember, you have to be at least age 70½).

To qualify as a QCD, the IRA trustee must make the distribution directly to the qualified charity. Any distributions, including any RMDs, which the IRA owner actually receives cannot qualify as QCDs....

IRA owners who have received their 2010 RMDs may not recontribute those distributions to an IRA to have them redistributed directly to a qualified charity as a QCD.

However, if an IRA owner received a distribution in excess of his or her 2010 RMD, the owner can roll the excess to another or the same IRA within 60 days of receiving the distribution and then have the funds paid directly to the qualified charity as a QCD.

Got that? One other thing to keep in mind: because you get a tax-savings benefit from a direct-from-your-IRA donation, you can't also claim the donation as a charitable deduction on your tax return. No "double dipping" allowed.

For more on turning an IRA distribution into a donation, see this article from the February 2009 issue of the Sound Mind Investing newsletter.

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Category(s): Giving and Stewardship, Retirement, Taxes
Tag(s): charitable donations, IRAs & 401ks

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Social Security closes "tax-free loan" loophole

People aren't stupid. If they see a way to earn a return with little risk, they'll act on it.

And that brings us to the topic of today's post: Did you know that for many years, some people have been getting interest-free loans from the Social Security Administration?

It's true. Social Security effectively allowed seniors to get temporary use of tens of thousands of dollars interest-free — until this week.

A 2009 U.S. News article described how it worked:

A little-known law allows Social Security recipients who are already collecting benefits to change their mind[s] and start over. An individual can claim Social Security at age 62 and then reclaim again for an enhanced payout at age 70, provided he or she pays back every cent already received.

No interest is charged on this "loan" from Social Security. So, an individual who doesn't need to spend their Social Security income on immediate expenses could feasibly invest the money and keep the interest. Upon paying back the principal, these investors will get higher Social Security checks for the rest of their life....

In order to take advantage of this zero-interest loan you need to be able to afford retirement without the monthly benefit. Boston College calculated that approximately 30 percent of men and 32 percent of women have enough financial assets in 401(k), IRAs, and other liquid investments to make it to age 70 without using their checks.

The Boston College study (PDF) referenced above didn't say how many households have been taking advantage of the claim/withdraw strategy, but it estimated that between $5.5 billion and $11 billion has been paid out annually to Social Security recipients who use the money for a while, earn a return on it, and then pay it back.

This week, however, the Social Security Administration slammed the door on that strategy, shortening the legal period between taking benefits and later withdrawing an application to one year. SSA also restricted the suspension period.

Here's an excerpt from a Social Security news release (PDF):

The Social Security Administration today published final rules, effective immediately, that limit the time period for beneficiaries to withdraw an application for retirement benefits to within 12 months of the first month of entitlement and to one withdrawal per lifetime.

In addition, beneficiaries entitled to retirement benefits may voluntarily suspend benefits only for the months beginning after the month in which the request is made.

The agency is changing its withdrawal policy because recent media articles have promoted the use of the current policy as a means for retired beneficiaries to acquire an "interest-free loan." However, this "free loan" costs the Social Security Trust Fund the use of money during the period the beneficiary is receiving benefits with the intent of later withdrawing the application and the interest earned on these funds.

The interesting thing is that Social Security rules have allowed for this "interest-free loan" arrangement since the 1960s, but the matter got little attention until the Boston College study mentioned above was published last year.

Here's something to think about: Were the people using the claim/withdraw strategy unethical? Or were they simply wise to use the regulations to their advantage?

We'll leave that for you to ponder.

Posted by Joseph at 1:20 PM | Comments (0) | TrackBack
Category(s): Retirement
Tag(s): Personal Finance Friday, Social Security

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Deficit commission on Social Security

Building on our post last week about the draft report from the co-chairs of the White House deficit commission, here's a separate article detailing the recommendations for Social Security.

Not surprisingly, the approach suggested is to make modest adjustments over an extremely long period of time. The retirement age would continue to rise, to 68 by roughly 2050 and 69 by 2075. Benefits would gradually be scaled back for wealthier recipients. Cost-of-living adjustments would be tweaked. The taxable wage base would be gradually broadened. More workers would be added to the system (new state and local workers after 2020 — didn't know they weren't already included).

Naturally, most everyone will find something to hate about this proposal (as they will with the broader list of recommendations).

That's what happens when compromise is required to solidify a budget, which is exactly what we're talking about here. Everyone smiles when it is expanded, and grimaces when it needs to be constrained. (Sounds pretty similar to every budgeting discussion we've ever had in my house.)

What's most striking to me in reading the Social Security recommendations, as well as the broader plan, is how doable all this sounds. I mean, really. For all the end-of-the-world-as-we-know-it carrying on of recent years, these changes really aren't that tough. (That's not to say we shouldn't all immediately go protest in the streets and burn stuff, as seems to be the popular response around the globe.) We're not talking about distributing ration cards here.

But for any of this to get passed, I think it'll all have to happen as one big package, and that concerns me because I'm not sure our politicians are serious enough to get something that significant done.

Taken together, most of the provisions put forth in these proposals seem pretty reasonable. There's a mix of distasteful medicine in there for everyone — rich, poor, old, young, Democrats, Republicans. And as long as everyone feels like this is legitimately a shared sacrifice, I think the people will accept it. (Wishful thinking?)

But if these provisions start getting split up into smaller proposals, forget it. That's when the problems start. Because if that happens, the seniors will get their legislators to kill the tough SS and Medicare stuff, the realtors will get their legislators to kill the home-mortgage deduction provision, the farm states will get theirs to kill the agricultural stuff, etc., etc.

Still in all, I'm encouraged by this report. There's nothing ruinous in here. Now granted, it doesn't solve all our fiscal problems either. But if we can get anything close to this passed, we'd be taking a huge step forward, one that would likely take a huge weight off the country's shoulders. If nothing else, it would help a great deal in turning the psychology around from the "we're all doomed, it's just a matter of time" feeling a lot of Americans have been carrying the past few years.

It can be done. Something like this is doable. Will our representatives rise to the challenge? That's the real question.

Posted by Mark at 8:55 AM | Comments (0) | TrackBack
Category(s): Retirement, Taxes
Tag(s): federal budget, federal spending, Social Security, taxes

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Retirement account contribution limits for 2011

The IRS has released its table of retirement-plan ceilings and thresholds for 2011 — and, because of low inflation, not much is changing from the 2010 levels.

Contribution and catch-up limits for 401(k)s, 403(b)s, and 457 plans remain exactly the same as they are for this year, as do the contribution/catch-up limits for IRAs.

What will change, slightly, are the income phase-out ranges for being able to (1) claim a tax deduction for IRA contributions and/or (2) participate in a Roth IRA. Details here from the IRS.

And for a helpful overview of retirement-planning issues, get a copy of IRAs, 401(k)s, and Social Security: A Retirement Planning Primer — SMI's new free report that explains how to craft a plan for long-term financial stability.

Posted by Joseph at 8:55 AM | Comments (0) | TrackBack
Category(s): Retirement
Tag(s): IRAs & 401ks

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Americans now expect to work more years than originally planned

The turmoil of the past two years has taken its toll on American-worker optimism about the financial future. Nearly two-thirds (64%) of those responding to a Sun Life "Unretirement Index" poll last month said the current economic crisis will delay their retirement plans by one year or more — up from 54% in a similar poll in late 2008.

As noted in the graphic below, nearly one-third (29%) of respondents expect to delay retirement more than five years.

The survey also found that 70 is the "new 65," with just as many Americans expecting to retire at age 70 as at 65. Other findings: four in 10 respondents believe Social Security benefits will not be as generous in the future as they are now. More than a third think Medicare benefits will be reduced.

Sun Life defines "unretirement" as working at least 20 hours per week after the age at which one is eligible to receive Social Security benefits.

"Our latest Unretirement Index shows that American workers have surveyed the damage of the economic crisis and are coming to grips with how long it will take them to rebuild their savings and how long they will need to remain in the workforce in order to do so," Sun Life president Wes Thompson said in a news release. "The Unretirement Index demonstrates how low confidence levels are impacting the American psyche and details the changes Americans are making in their saving and spending habits as a result," he said.

So what are respondents doing about their concerns? The study found that 71% have cut their spending, 66% are reducing debt, and 46% are saving and investing more.

To help you engage the realities of retirement planning in today's economic environment, SMI has just published IRAs, 401(k)s, and Social Security: A Retirement Planning Primer — a free report that'll show you how to craft a plan for future financial stability.

Click here to learn how to get a complimentary copy.

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Category(s): Retirement

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Long-term-care premiums set to soar

The Wall Street Journal reports that several large providers of long-term-care insurance policies have sought permission from state regulators to raise premiums on existing policyholders by 10%-40%. Some of these companies stopped selling new policies several years ago, recognizing that the numbers just weren't adding up.

Now, regulators are in the uncomfortable situation of trying to arbitrate between the lesser of two evils: raising premiums on strapped policyholders, or taking the risk that inadequate premiums are going to leave insurers without the means to pay claims decades down the road.

For those stuck with a large premium increase, the article advises against canceling the policy:

Faced with steep rate increases, many people will want to drop their coverage. But that step is "usually one of the worst things policyholders can do," says Gary Cotter, a financial planner at Cotter Financial LLC in Sun City Center, Fla. After all, those who walk away from a policy "have paid all this money and get nothing back."

In deciding the best course of action, you should first consider factors including your financial resources, age, health and need for other forms of insurance coverage. If you want to retain your current level of coverage but are too strapped to pay a higher premium, some advisers recommend asking one or more heirs to help out. Each heir can give any one person up to $13,000 this year free of gift tax.

Policyholders can ask their carrier to modify their coverage to bring premiums down. For example, carriers may allow policyholders to reduce the daily or monthly costs covered by policies — say, to $150 a day from $200. Or, they can expand the "elimination period," the number of days the policyholder must pick up the tab before benefits kick in — say, to 90 days from 30 days.

It's often uncomfortable for families to talk openly about financial issues, but this is one case where it really can make a big difference. It's probably not doing your kids a favor to cancel a policy that would help with your future care, if they're likely going to try to provide that care in the absence of the policy. It's at least worth discussing together first.

Posted by Mark at 10:35 AM | Comments (0) | TrackBack
Category(s): Family Finances, Retirement

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SMI releases new FREE retirement planning report

It's Personal Finance Friday, and today we're focusing on preparing for retirement (plus we have a special freebie for you — read on!).

SMI has never endorsed the idea that when people arrive at certain age they should give up all productive endeavors and go spend every day on the golf course or at the lake. We think a person's later years can be spent in all kinds of productive enterprises, especially those that relate to strengthening family ties and advancing the Kingdom of God. And if your health is good, you might even want to keep working.

But even if you plan to keep earning an income well past normal "retirement age," it's wise (and good stewardship) to build up savings now so you will have adequate financial support later.

Regrettably, many people are failing to save enough when they are young or middle-aged, according to retirement-funding studies.

In the decades ahead, that lack of savings, when combined with possible cuts in Social Security benefits, is likely to mean that Americans will be forced to work longer, competing for a limited number of employment opportunities that may not pay as well as current employment.

To help you think through the realities of retirement planning, we've prepared a complimentary new report, IRAs, 401(k)s, and Social Security: A Retirement Planning Primer. The report explains the "three-legged stool" of retirement income: Social Security, private employer-sponsored retirement plans, and personal retirement savings. We believe it will help you craft a plan to ensure future financial stability.

The report includes:

• An overview of the Social Security system — and why cuts are likely ahead;
• A review of the pro and cons of different types of employer-sponsored plans;
• An explanation of the differences between a "traditional" IRA and a "Roth" IRA;
• A discussion of how to keep taxes to a minimum; and
• Advice on why to consider an IRA, even if you have an employer-sponsored plan.

For details on how to get complimentary copy of IRAs, 401(k)s, and Social Security: A Retirement Planning Primer — or our other FREE report, Seven Key Principles for Christian Investing — click here.

Next week's Personal Finance Friday post will look at two easy-to-use (and free!) services that can save you money and simplify your life. How 'bout that!

Spend wisely — and have a great weekend!

Posted by Joseph at 12:55 PM | Comments (0) | TrackBack
Category(s): Retirement
Tag(s): Personal Finance Friday, retirement

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Missed it by that much

American workers are short on retirement savings. How short? $6.6 trillion short, if this new study is to be believed.

As usual, there are things to quibble about with the study's methodology. In this case, the study assumes a paltry rate of return of 3% on invested assets. Given that the survey covers workers aged 32-64, hopefully that rate will end up being too low.

But if they're even half right, that's still a big deficit to make up.

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Category(s): Retirement

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Employees still taking huge risks with their 401(k)s

We've been writing for years about the huge risk employees take with their 401(k) savings when they invest a large portion in the company stock of their employer. And while the trends have improved over the years, this new Forbes report indicates a whole lot of employees have yet to get the message.

For example, when we last wrote about this issue in December 2007, 57% of the assets in Coke's 401(k) plan were invested in Coke stock. Forbes says that level is 51% today. Better, but not much.

Let me put it bluntly for the benefit of new readers. This is one of the biggest risks "normal" people take with their retirement savings. It's also one of the most easily correctable ones, in most cases.

I've heard people agonize about the decision to reduce the amount of company stock they own. In many cases they legitimately believe their employer is a great investment — significantly better than the alternatives they would invest in if they were to sell company stock. Some of them are even right about that.

Unfortunately, it's a risk you can't afford. The landscape is littered with the carcasses of blue-chip, brand name companies whose employees never dreamed they would fail. And yet they did. You simply can not take the chance that your retirement savings will be devastated at the same time you lose your job and benefits. That's way too many eggs for any one basket, no matter how confident you are in that basket.

Posted by Mark at 1:05 PM | Comments (0) | TrackBack
Category(s): Investing Principles, Retirement

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401(k) plans changing their tune?

For years, my impression has been that former employers are generally happy enough to see you transfer your 401(k) balance to an IRA (particularly if the balance isn't very large). Indeed, some plans even force former employees to move their balance within a certain amount of time.

That "move 'em out" mindset appears to be changing. With the retirement of the boomer wave of workers, many of these plans appear on course to shrink in the coming years, and 401(k) plan providers don't like that.

Naturally, IRA providers — which include both brokers (Schwab, Fidelity, TD Ameritrade) and mutual fund companies (Vanguard, tons of others) — have aggressively targeted these assets for years. Only recently have 401(k) providers started fighting back.

IRAs offer a lot more flexibility than most 401(k) plans, which is why SMI has always leaned toward retirees rolling 401(k) assets into an IRA — especially for investors who want to follow our highly successful Fund Upgrading strategy.

Naturally there are a few exceptions that would give the nod to 401(k)s instead, such as:

• If you're an indexing fan and have great low-cost index fund options available in your 401(k);
• If you are between ages 55-59;
• If you have company stock held in your plan.

In other words, it pays to look closely at the details of your specific situation. But unless you have a specific reason to stay, we think most retirement investors are best served by rolling any old 401(k) accounts to IRAs.

Posted by Mark at 9:10 AM | Comments (0) | TrackBack
Category(s): Retirement
Tag(s): retirement

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Lobbying for more options in your 401(k)

"My company retirement plan has a lousy set of fund offerings. How do I convince my employer to offer more (and better) options?"

One of our readers e-mailed with this question recently. For the benefit of other readers in the same boat, I thought I'd publish my response here on the Weblog:

The best possible outcome would be for your employer to add a "brokerage window" or "self-directed" option to your 401(k) plan (or your 403(b), if you work for a not-for-profit). Such an option would allow you to invest in funds offered by a brokerage firm selected by your plan administrator.

A couple of years ago, my wife's employer (a small college) added a brokerage window. The number of funds from which we could choose grew, literally overnight, from about 20 to hundreds. (And, of course, I immediately moved her retirement money from some slow performers into SMI's Upgrading recommendations!)

Getting your employer to make positive changes to your 401(k) will require convincing the benefits decision-maker that such a change is in the company's best interest. The folks at The Motley Fool offer a helpful guide on how to build a persuasive case. (They even include a sample letter to send to your company-benefits director!)

Fodder for your letter will come from your plan's Summary Annual Report, Summary Plan Description, and/or Fee Arrangement. Request a copy from your company's 401(k) plan point person. (It may be someone in your human resources department, or even the company CEO or CFO if you work for a smaller outfit.)

Buried in these documents is the dirt on the fees your plan charges — both the investment expenses and the plan expenses — and whether your boss covers administrative costs or if they are passed through to plan participants (that's you)....

"In a half hour, you can figure out what your expenses are," says Stop the 401(k) Rip-off! author [Google Books preview] and retirement-plan industry veteran Dave Loeper. "If you find out that you are getting ripped off, the next step is to complain to your employer without sounding like a complainer."

Since this topic can be touchy, your aim is to inform, not complain, Loeper says. Don't focus on the needlessly high expenses you're paying. Instead, note that you have calculated the expenses you're paying and are wondering if there are some lower-cost alternatives available. Judiciousness should be your default mode. You've got to convince your company that, in dollars-and-cents terms as well as employee-satisfaction terms, something needs to change.

This Morningstar article (free registration required) covers some of the same territory as The Motley Fool piece, but lays out additional options.

If adding a brokerage window is "a bridge too far" for your employer, you need a fallback position — namely, requesting the addition of several low-cost index funds. The Wall Street Journal reported a few weeks ago that more employers are adding index funds to their plans, so there might be a trend here your employer would be willing to follow.

But, as the WSJ notes, getting indexes added presents its own challenges.

The stodgy 401(k) world won't change strategies overnight. Fund companies won't easily relinquish their active-management fees, which tend to be higher than those charged on index-tracking products, especially at a time when rocky markets are pinching profits. And actively managed funds tend to do more "revenue sharing," which involves fund companies making payments to plan administrators.... (emphasis added).

Still, some big players are betting that the stars will begin realigning....

In a recent survey of about 150 employers by consulting firm Hewitt Associates, 17% of them said they are likely this year to replace some or all of their plan's actively managed investment options with index funds. That is up from 8% a year earlier....

Some smaller plans that don't have the purchasing power to access the lowest-cost index funds on their own are banding together in multiple-employer plans that take a passive approach.

(The WSJ also takes note of "a spate of recent lawsuits [in which] workers have claimed their 401(k) plans charged excessive fees and offered actively managed funds that failed to beat cheaper index-tracking alternatives." For an example, see here. This is probably not something you want to bring up in a confrontational way — you don't want to come across as adversarial — but the fact that some employees are willing to go to court reinforces that this is an important issue to workers and one employers need to be aware of as well.)

If you can get your employer to add even just a handful of index funds representing the major market categories (large companies, small-medium companies, international stocks), you could put together something similar to our Just-the-Basics strategy. Such an approach is likely to offer superior results to being invested in not-too-stellar pre-chosen funds.

Workers with limited fund options within their retirement plan will likely benefit from reading our research on how to choose funds in your 401(k) when your options are few (SMI web membership required). When we tested this simple approach a few years ago, its returns more than tripled the broad market's over the 8-year test period!

Posted by Joseph at 4:02 PM | Comments (0) | TrackBack
Category(s): Family Finances, Retirement

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The next bailout

Fortune's senior editor at large, Allan Sloan, says the next government bailout will be for a familiar program: Social Security. And if you thought AIG was bad, you haven't seen anything yet.

Many people have painted grim portraits of this program's future. Few have ever made the case that it could go cash-flow negative as early as this year. Sloan explains how that could very well be the case.

Sloan does an excellent job personalizing the way Social Security works — and doesn't work — through the use of his own example. It's a solid job of taking subjects most people really don't understand (like the Social Security "lockbox") and making them simple enough to grasp.

But more than just banging the drum of alarm, Sloan also offers several reasonable changes that would go a long way towards putting the program on a more secure footing. It's worth a read, if for no other reason than to prepare yourself to really understand this crucial issue that President Obama has promised is next on the reform agenda after the health care battle ends.

Update: Related item of interest — a new Rasmussen poll finds that "49% of U.S. voters say working Americans should be allowed to opt out of Social Security and provide for their own retirement planning."

Posted by Mark at 4:16 PM | Comments (0) | TrackBack
Category(s): Retirement

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Backlash against AARP; seniors quitting, moving membership

The New York Times reports on "a mini-mutiny at AARP" — the older-Americans advocacy group that has angered many of its members by supporting an overhaul of the U.S. health care system.

Between 50,000 and 60,000 AARP members [out of 40 million] have left the organization since July 1, a spokesman for the group said.

Many of the defectors have destroyed their AARP cards and are switching to a relatively new group called American Seniors Association, which bills itself as the conservative alternative to AARP....

In explaining A.S.A.'s opposition to a health care overhaul, Stuart Barton, the group's president, wrote on Monday that "a government-run plan would limit patient-doctor choice," that "an employer mandate would kill jobs and lower wages," and that a new plan would require higher taxes and Medicare cuts that hurts baby boomers and seniors.

The A.S.A. is appealing directly to disaffected AARP members, urging them to cut or tear up their AARP cards and join A.S.A. at a discount....

Jim Dau, a spokesman for AARP, said in an interview that while AARP took such rebellions seriously, it had endured them before. In 2003, it lost 70,000 to 80,000 members over its support for a Medicare prescription drug program. In 2005, the organization lost 8,000 to 10,000 members for opposing efforts to privatize Social Security....

In SMI's September 2007 issue, we highlighted six organizations for seniors that are alternatives to AARP.

Posted by Joseph at 9:30 AM | Comments (0) | TrackBack
Category(s): Health Care, Retirement

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Fraud "not uncommon" in 401(k) hardship withdrawals

One result of the rocky economy has been a sharp rise in requests for "hardship distributions" from 401(k) retirement plans.

Employers aren't required by law to allow for hardship distributions, but many do — or at least they have until now.

That might change. The publication Workforce Management reports that hardship-withdrawal fraud (committed by employees who want to avoid penalties for early withdrawals) is "not uncommon."

Last week, home-shopping retailer QVC suspended more than 200 employees at its North Carolina distribution plant, pending an investigation of hardship-withdrawal fraud.

From Workforce Management:

In an August 4 letter to suspended employees, Nick Brecker, vice president total rewards at QVC, said that his team...along with the company’s 401(k) administrator, Fidelity Investments, [had reviewed hardship applications] and determined that some applications "may not contain complete or valid supporting documentation..."

A posting on the web site of a North Carolina TV station alleges that multiple employees used the same fake documents (related to such things as forecloses and medical issues) to support their claims, raising a red flag for QVC and Fidelity.

QVC says suspended employees found to be innocent will be reimbursed for workdays missed. Employees deemed to have committed fraud could be fired and face legal action.

Earlier this year, SMI reported on a legal option for getting money out of 401(k) while avoiding an early withdrawal penalty.

Posted by Joseph at 2:23 PM | Comments (0) | TrackBack
Category(s): Retirement

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More index funds and ETFs coming to 401(k)s

Ninety percent of 401(k)/403(b) money invested in mutual funds is in actively managed funds, even though, as a whole, such funds tend to perform less well over time than passively managed index funds.

The main reason retirement accounts are way overbalanced toward actively managed funds is simply that — for various reasons — many employer-sponsored plans don't offer the option of index investing. But the times they are a'changin'.

A trend is emerging toward adding indexes (and exchange traded funds) to defined-contribution plans, according to a report in the Wall Street Journal:

The stodgy 401(k) world won't change strategies overnight. Fund companies won't easily relinquish their active-management fees, which tend to be higher than those charged on index-tracking products, especially at a time when rocky markets are pinching profits. And actively managed funds tend to do more "revenue sharing," which involves fund companies making payments to plan administrators....

Still, some big players are betting that the stars will begin realigning.

Money manager BlackRock Inc., known largely for its actively managed products, last month stressed the potential for index funds' growth in retirement plans in announcing its acquisition of indexing giant Barclays Global Investors....

In a recent survey of about 150 employers by consulting firm Hewitt Associates, 17% of them said they are likely this year to replace some or all of their plan's actively managed investment options with index funds. That is up from 8% a year earlier.

While the largest employers have long had access to the lowest-cost index funds, many small and midsize plans, which have typically been sold pricier funds, are now demanding passively managed products, too....

Some smaller plans that don't have the purchasing power to access the lowest-cost index funds on their own are banding together in multiple-employer plans that take a passive approach.

In the best of all possible worlds, of course, employees would have access both to indexes and actively managed funds. But if some companies are going to make an either/or choice (as some apparently are, judging from the WSJ article), employees would be better served by having several indexes from which to choose.

If you're part of an employer-sponsored plan that now lacks indexing options, you may want to print the WSJ article and give it to the HR person at your office, perhaps along with a brief note that says something like, "Interesting trend. It'd be great to have some index funds in our plan! Would you check into that, please?"

Having access to several good index funds will enable you to implement SMI's Just-the-Basics strategy through your 401(k)/403(b). To be sure, being able to Upgrade via your retirement account would be even better. But indexing is a simple, solid approach to retirement investing.

Posted by Joseph at 4:33 PM | Comments (0)
Category(s): Retirement

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401(k) / group annuity plans

Forbes has a disturbing article on certain 401(k) plans set up as "group annuities" by insurance companies. By their account, "Among 401(k) plans with assets of less than $250 million, group annuity-style menus account for 55% of the market and are sold by axa Equitable, Lincoln Financial and other insurers." These group annuity plans charge ridiculous fees and often lock participants into those fees for years.

Not all 401(k) plans with annuities are necessarily bad. But some sure are. If you're in a plan with annuity investment choices (or one that is run by an insurance company), you should read the article and ask appropriate questions to make sure you're not in a plan like the ones they describe.

Posted by Mark at 3:13 PM | Comments (0)
Category(s): Retirement

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Maximizing income from CD's

James Stewart of SmartMoney has a counterintuitive strategy for investing in CD's (certificates of deposit, not the musical variety). Instead of buying longer maturities in order to get slightly better yields, he thinks savers should currently be shortening their maturities.

In this environment, I have a suggestion that bucks the conventional wisdom: Instead of lengthening maturities, shorten them. You don’t have to give up all that much income; you don’t have to worry about rising interest rates eroding your principal; and the short maturities guarantee that, in the event CD rates do rise, you’ll be in a position to take advantage of them when your CDs mature.

Given the modest improvements in yield from a one-year CD to a two-year (his article quotes national averages of 2.1% for one-year and just 2.3% for two-years), I think he's right. You might give up a tiny bit of income, but chances seem good that sometime within two years you'll make that up by being able to roll-over into higher yielding CDs.

Posted by Mark at 4:32 PM | Comments (0)
Category(s): Current Market Events, Retirement

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More on TIPS

Yesterday, I linked to an article warning about the pitfalls of I-Bonds and reiterated that we think TIPS are a better way to add inflation protection to your bond portfolio. But that's not quite the end of the story.

Today, the Wall Street Journal points out the fact that TIPS mutual funds may not be as great an inflation hedge as you might expect. This is somewhat speculative, as TIPS are only about a decade old, and there hasn't been a period of significantly rising inflation during their brief life. So nobody knows exactly how they will behave. But that doesn't mean we can't make educated guesses, which is what this article does.

I encourage you to read the whole article, but in a nutshell, here's the deal. When you buy an individual TIPS bond, you get a fixed interest rate plus an adjustment for inflation. If you hold the bond to maturity, you get your full principal back. Pretty straightforward. The only moving component is the inflation adjustment, which moves up or down based actual measured inflation.

When you buy a TIPS fund however, you're buying a pool of TIPS bonds that have all manner of different maturity dates. Those individual bonds go up and down in value each day, primarily based on what interest rates are doing. In other words, with a TIPS fund, you introduce the impact of daily valuation changes into the equation, whereas when you buy a TIPS bond and hold it to maturity, there are no valuation changes. The individual TIPS bond is only going to fluctuate based on inflation changes, whereas the fund is going to fluctuate based on inflation changes as well as interest rate changes (which impact the demand for those bonds).

Here's how one expert interviewed for the article sums up these factors:

Anne Lester, a senior portfolio manager at J.P. Morgan Funds, has looked at how TIPS fit in a portfolio as an inflation hedge. During an inflation surge, she says, interest rates would be a negative for their prices. However, demand for TIPS likely would grow, supporting prices. Putting it all together, she says, TIPS would likely be a good shield against inflation, “but less inflation protection than you want.”

Ms. Lester’s group identified another set of circumstances that could lead to losses in TIPS: interest rates rising but inflation falling. Between July 1980 and July 1981, interest rates rose to about 15% from 10% while the CPI fell to 10% from 14%. The result: a“perfect storm” that could have sent TIPS down by about 20%.

Note that those hypothetical losses would impact TIPS fund holders, but not holders of individual TIPS who simply hold on to maturity. Those changes in value would apply if they were to sell their individual TIPS at that time, but could be avoided by holding to maturity, at which point their full principal would be returned.

SMI has typically focused on buying TIPS funds, primarily because it's so much easier for most investors. There are several good ones around, like Vanguard's VIPSX. But this does introduce a question regarding whether at least some investors might be better served going through the aggravation of buying individual TIPS bonds instead. They can be purchased through TreasuryDirect.

I'm not totally persuaded that everyone needs to suddenly quit using TIPS funds and start buying individual TIPS instead. The trade-off between maximum benefit and ease-of-use isn't completely settled in my mind. But it does make me think we'll need to ponder this "individual TIPS vs. TIPS funds" issue a bit more.

Bottom-line, we do think beginning to shift from traditional bonds to TIPS makes sense. TIPS are currently priced as if future inflation will remain low for many years. As you know if you've been reading recent SMI material, we too feel that deflation (rather than inflation) is the immediate threat. But we're also pretty convinced that as economic activity begins to pick back up eventually, so will inflationary pressures. If so, having switched from traditional bonds to TIPS (when they were priced for deflation) should pay off.

Posted by Mark at 2:36 PM | Comments (0)
Category(s): Current Market Events, Retirement

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If your employer cuts your retirement-plan match

Since the middle of last year, at least 200 companies have either reduced or suspended matching contributions to their 401(k) plans. The Big Three automakers are among them, and so are Sears, UPS, Xerox, Black and Decker, Forbes, and Starbucks. (More on this list.)

If your employer follows suit, should you keep contributing? Or should you redeploy your resources elsewhere? After all, losing the match — or a significant portion of it — removes one of the key advantages of a 401(k).

As with many financial questions, the answer is: "It depends."

If you have consumer debt, it may be more financially advantageous to stop your retirement contributions for awhile and use that money to pay down your debt. Remember, paying down debt yields a guaranteed return. Reducing the cost of borrowing has the same bottom-line effect as increasing the return on your investments.

Another option is to redeploy your retirement contributions into building up your emergency savings. Having a financial cushion will be invaluable if your employer is eventually forced to cut your position and you find yourself out of work.

One more option — if you're already clear of consumer debt and have your emergency savings in place — is to redeploy your company 401(k) contributions toward a personal IRA. There is not much reason to do this if you are satisfied with the choices in your employer's plan. And besides, your employer might re-institute the match when the economy turns around.

But if you've been unhappy with the options in your company 401(k) and think it might be awhile before the full matching program is resumed, opening your own deductible IRA or Roth IRA might be a good choice. A deductible IRA will offer you an upfront tax benefit, of course, but if you think taxes will be higher in the future (and it is certainly looking that way) the Roth is more attractive because your withdrawals in retirement will be tax free.

A word of caution: if you suspend your retirement contributions to pay down debt or build your emergency savings, be sure to resume your retirement funding once your debt payment and/or savings goals are met. Waiting several years to re-launch your retirement savings is likely to have a large negative impact on your future nest egg.

Posted by Joseph at 3:44 PM | Comments (0)
Category(s): Retirement

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401(k)/403(b) contribution limits for '09

The yearly amount you're allowed to set aside in a 401(k) or 403(b) retirement plan went up by $1,000 last week. For 2009, the limit is $16,500, a 6.5% increase over the $15,500 limit in 2008.

The limit for "catch up" contributions has risen, too. If you were born before 1960, you can contribute an additional $5,500 to a 401(k) or 403(b) - up from $5,000 last year - for a total contribution of $22,000.

Related: The changes in 401(k)/403(b) limits are mirrored by the government's Thrift Savings Plan for federal employees. The elective deferral limit for 2009 is now $16,500, and the limit on catch-up contributions (for those born before 1960) has risen to$5,500.

Unfortunately, the contribution limit for IRAs remains unchanged for 2009. It is still capped at $5,000, although workers who are 50 or over can set aside $6,000.

The Wall Street Journal has a round-up of tax changes that took effect on Jan. 1, including a simple table showing the 2009 federal income tax brackets.

Of course, tax brackets and rates are subject to change.

Posted by Joseph at 2:18 PM | Comments (0)
Category(s): Retirement

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